Sygnum Market View – 11 January 2021

Bitcoin and Ethereum have been repeatedlysetting new all-time highs, surpassing USD 40,000 and USD 1,200 last week. Is the rally sustainable? In this week’s edition of Sygnum’s Market View, we discuss 3 metrics from the futures market which can be used to identify a market top.

1. Perpetual futures funding rates

A perpetual futures contract is a futures contract (a contract to buy or sell an asset in the future) without an expiry date. To keep prices on these contracts in line with the spot market, there is a mechanism called the funding rate. When the perpetual futures market is trading at a price higher than that of the spot, there is a positive funding rate where longs pay shorts. This is expected to bring down the price (and funding rate) as longs are incentivised to close their positions and more shorts are opened. The reverse happens when the futures market trades at a price lower than that of the spot.

A high positive funding rate points towards a market where participants are willing to keep their long positions despite high interest rates on them. However, without a price increase in the underlying market to offset the interest payments, this will eventually lead to the closing of an otherwise too expensive position and thus selling pressure. Funding rates tend to fluctuate between +/- 0.05%, and the mean funding rate across all major platforms is currently +0.07%.

2. Term futures basis

The term basis is the premium that a (fixed expiry) futures contract trades at compared to the spot price. This indicates how much increase (contango) or decrease (backwardation) the market prices into a given timeframe. In general, the annualized premium ranges from single digit percentage points up to 20 percent, with anything higher being quite overstretched.

Below are the current annualised premiums for futures contracts expiring in the coming months -

March: ~20%

June: ~16%

September: ~15%

3. Open interest

Open interest (OI) is the total number of active futures contracts held at the end of the day. While it does not provide a directional indicator, it reflects overall investor appetite, with steady growth signalling a strong and convicted market. The two occurrences of a noteworthy open interest drop in 2020 (March and September) have been accompanied by heavy selloffs in the market. At the moment we are seeing a strong upward trend in open interest.

Calling the top

These metrics provide data to help assess the short to mid-term state of the market. However, signals are (almost) always ambiguous and there will rarely be a situation where all indicators point in the same direction. In addition, as economist John Maynard Keynes once said, “the markets can remain irrational longer than you can remain solvent.”, and this has proven true on several occasions with the crypto market continuing a bull run despite many sell signals.

This is an interesting and exciting time for the crypto market. While it is anyone’s guess if the Bitcoin and Ethereum price rally will continue, the potential of cryptocurrencies grow in acceptance and maturity.

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