Sudden Upheaval in Bitcoin Perpetual Futures: Analyzing the Volatility and Risk Factors

A turbulent ocean under a stormy sky, waves symbolizing volatile Bitcoin futures. Steep cliffs in the background represent the sudden drop in funding rates. A lonely ship, fighting against the waves, embodies traders in the unpredictable crypto market. Artistic style: Romanticism, Mood: Uncertainty

In a recent abrupt shift, bitcoin’s volatility index, referred to as DVOL, climbed from 36% to 48.5% on an annualized basis. Crucially, the funding rates for Bitcoin perpetual futures dipped globally, causing quite a stir. A significant plunge in the rates on OKX, Deribit and Bybit saw them hit -10% or more in annualized terms.

Perpetuals, specifically, are futures without expiration dates. They employ a funding rate mechanism to align perpetual prices with the index price. When the funding rate dips below zero, bearish short positions dominate, necessitating shorts to pay longs in order to sustain their bets. The converse occurs when rates surge into the positive terrain – a predominance of bullish positions.

The substantial drop in funding rates may have occurred in response to a sudden price dip in Bitcoin, which caught off guard traders who had been shorting options for profit amidst a sustained volatility slump. These traders possibly sold perpetual futures to hedge impending risks from a volatility spike, thereby worsening the price drop.

Griffin Ardern, a volatility trader from Blofin, contends that the unexpected price drop led to hedging behaviours, thereby catalysing a deeper decline. To him, option sellers were too heavily invested in put options, due to the previously bullish trend in the market.

Moreover, reports hinting at Deribit‘s disposal of perpetuals, in order to liquidate a substantial short volatility position, roused some speculation. Notably, Deribit oversees about 90% of the crypto options market. Consequently, the vast majority of volatility selling in recent times took place on Deribit. At some juncture on Thursday, Deribit‘s BTC perpetual futures traded at $2,000 below the digital currency’s average spot price across different exchanges.

Information from representatives at Deribit disclosed a recent alteration to the exchange’s liquidation policy. The policy was adjusted to liquidate with whichever instrument posed a problem, promising to be more effective in risk management.

So, as we scrutinize this scenario, it’s clear how these dynamics are evolving. The sharp shifts in funding rates accentuate the risk these derivatives bring, revealing a bigger picture of the intricate world of crypto markets. While they allow traders to bet on price movements without holding the actual crypto, they evidently come with their own set of complexities. This event underscores the importance of a deeper comprehension of the instrument one is dealing with when entering the world of crypto futures.

Source: Coindesk

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