There has been some bearish dynamics in the bitcoin price in recent days, so what is the reason? One of the main catalysts is the level of leverage (use of borrowed funds) in the crypto derivatives market.
There is a decline in the price of bitcoin combined with a decline in the funding rate from the highs. This shows that the bulls in the derivatives market have somewhat outperformed the bitcoin spot market and have speculated on a leveraged price increase. If/when this price increase does not occur, these traders are at a disadvantage and leveraged positions are forced to close.
The table below describes the state of the bitcoin open-ended swaps market as of early November 17, with mostly neutral positioning after falling below $60K: classic speculators being forced out of the market.
One of the things that is so often misinterpreted in the bitcoin market is that discovering new price levels and the volatility inherent in the market is a way to get rid of any market participants who are overextending their leverage. Big buyers and sellers in the bitcoin spot market often watch the derivatives market closely because they know that if the derivatives market deviates significantly up or down, they can make a lot of money by forcing traders to close their positions at a loss.
That’s what happened earlier in the week. Nothing significantly changed in the dynamics of onchain accumulation or the macroeconomic backdrop. Rather, the bitcoin market is getting rid of speculators before moving on to the next phase.
Volatility is the price you pay for profits in the bitcoin market, and someone who wants to increase those profits even more through excessive leverage, unless they are an expert in risk management, can end up either with no bitcoins at all or with far fewer of them.
This is why self-storage of spot bitcoin is by far the best way to participate in the market. Short-term volatility is just noise if you understand where you are investing.
Rising correlation of cryptocurrency stocks
The bullish long-term onchain picture for bitcoin remains largely unchanged given recent derivatives liquidations. We are trying to understand what will happen in the broader macroeconomic environment over the next few months and how this will affect bitcoin price performance. Barring a major macroeconomic correction over the next few quarters, bitcoin is still poised for a major bullish move.
The 90-day moving correlation of bitcoin with the S&P 500 Index is back to 5-year record highs. The correlation jumped to new highs at the start of the pandemic and is now returning to those levels. Realized correlations have also been rising for the month, peaking at 63.4% in September. Although bitcoin is rising as an independent asset class, the U.S. stock market capitalization is still $54 trillion compared to bitcoin’s $1.1 trillion. The narrative of reduced market risk spreading to U.S. equities will have an impact on the bitcoin price as well.
We highlighted the correlation between bitcoin and the S&P 500 Index during the recent market correction related to the Evergrande Group’s problems in a review:
“The continued macro correction in the S&P 500 and global markets in general continues to create the most meaningful risk of a slowdown in bitcoin’s ‘double bullish cycle’ in Q4. Virtually every BTC correction in 2021 has correlated with the S&P 500 correction. And while little has changed in the bullish onchain dynamics of Bitcoin, which we have written about extensively in recent months, indicating a larger upward move is coming, in the short term BTC price swings are also dependent on movements in much broader markets.”
Bitcoin may be on its way to becoming a reliable inflation hedge and long-term safe haven asset for its owners in the future, but right now it is still a risky, speculative investment for many investors in the market. There is no doubt that the price of bitcoin has benefited over the past decade from the “everything bubble” we are in today. Now the question is where will the S&P 500 speculation go next, and how will bitcoin respond?
Even amid growing concerns about inflation and talk of raising interest rates, our understanding of the broader economic situation is that stock market growth is a matter of national security for the United States. The U.S. government and the Federal Reserve Board must continue to support market growth or risk a credit collapse and market recession. As a result of this support through increased fiscal policy and continued manipulation of the cost of raising capital, our thesis is that bitcoin will continue to gain more traction and more capital coming online, further distancing itself from correlation with risky assets.