What was the impact of the recent crypto-market capitulation on exchanges?

Most investors and traders are still trying to come up with a narrative that explains the meltdown across crypto markets over the past week. While there are many speculations, a logical theory is that large-scale margin calls across global equity markets have forced investors to liquidate their crypto holdings to fund the losses. Consequently, the liquidity stress in global markets have caused a drag on cryptocurrencies as well. 

Chart 1 - BTC prices capitulated from $7900 to $4700 in one day

Source: Tradingview

Crypto markets witnessed a bloodbath as BTC prices collapsed to its yearly lows. In less than a month after reaching its peak of $10,500, Bitcoin lost 50% of its market value. The sell-off marks a dramatic turn of events as market sentiment turns sour after a good start to the year.

Traders’ sentiment indicated “Extreme Fear”

Investors saw their year-to-date gains on Bitcoin and altcoin markets wiped out in a matter of days as waves of panic selling hit the markets. Following a good start to the year, sentiments among investors and traders have turned sour, as shown by the Bitcoin Fear and Greed Index. As chaos unfolds across crypto markets, the index has indicated “Extreme Fear” on consecutive days over the past week.

Chart 2 - Crypto Fear & Greed Index hit a 3-month low

Source: alternative.me

On March 12th, Bitcoin collapsed from $7,900 to $4,700, declined by 40% within hours. The heightened volatility continued the following day, with the lowest point being recorded at $4,000. In fact, BTC prices went as low as $3,800 on some exchanges. Consequently, the Fear and Greed Index moved towards its lowest point since December 2019, a move that caught most traders off guard. 

Major exchanges stumble under pressure

During the chaotic period of trading, several major crypto-exchanges struggled to cope with the surge in trade volume and volatility. As if the surge in volatility and selling pressure wasn’t stressful enough for traders, technical issues on several exchanges piled onto their burden. 

Some exchanges suffered from system outages, overloads, and unexpected downtime. Given how volatile the markets were, these technical issues added more panic into the markets. Evidently, some exchanges were not prepared to handle mass liquidations, which saw 90% of long positions getting REKT. As traders face heavy losses following the debacle, these exchanges are now contending with massive criticism from its users.

The combination of heightened volatility and system outages resulted in a significant reduction in market liquidity. As such, traders noticed large price spreads between the best bids and offers on major exchanges, fueling an extremely volatile trading environment. Bitcoin fluctuated wildly between $6,000 and $4,000, with prices on the short-term timeframe moving by more than $1,000.

On the contrary, traders on Binance Futures avoided any prolonged outage and had a relatively stable trading experience amidst the extreme market volatility. In the same period, the Binance Futures trading platform continued to operate smoothly with no problems and delays. 

Importantly, traders on Binance Futures were able to transact in and out of the market without any problems, unlike in other exchanges where users were unable to complete transactions and faced congestion issues amidst the volatile trading period.

Open interest obliterated

Following a bull market in January, many traders were caught off guard as market sentiments reversed, triggering a series of liquidations across major exchanges. As a result, major exchanges reported a sharp decline in Bitcoin Futures’ open interest after prices crashed below $5,000 last week. 

Chart 3 - Aggregated open interest in BTC futures collapsed by 50%

Source: Skew

According to Skew, the open interest across major exchanges witnessed a steep fall from $5.3 billion on 17th February to $590 million 16th March, a decline of almost 90% in one month.

A common phenomenon that analysts would observe in previous bear markets would be the combination of growing open interest and volumes followed by a decline in prices. This phenomenon indicates increasing short positions as traders anticipate lower prices.

However, based on market behavior in the past week, we observed a sharp fall in open interest and prices, which were accompanied by rising volumes. This combination of factors is not a common phenomenon that traders would observe under normal circumstances, which clearly showed that traders did not anticipate the dramatic sell-off.

Lack of buying interest affected funding rates

Noticing the strong downside momentum, many traders flooded the market with sell-orders in hopes of participating in the downtrend, resulting in a lack of buying interest. The surge in short interest eventually drove funding rates on perpetual swap contracts into negative territory. 

Chart 4 - BTC perpetual swaps funding rates

Source: Skew

As shown, funding rates, which are normally positive, turned negative as perpetual swaps were priced lower than the spot index. In such cases, traders who hold short positions will pay for long positions. During this period of extreme volatility, most exchanges observed their fundings rates surged more than 7x larger than the historical mean.

Record-breaking volume across major exchanges

Major exchanges recorded a significant rise in volumes as traders rushed to capitalize on opportunities. Aggregated daily volumes began to climb on March 12th and ultimately reached an all-time high, recording $47 billion worth of contracts traded in a day.

Chart 5 - Weekly volumes across the top 5 crypto exchanges

Source: Binance Futures

The aggregated weekly volume across the top 6 crypto-derivative exchanges rose from $95 billion to $194 billion during the week. Binance Futures recorded a new all-time high, with over $9 billion traded in a single day. 

In general, derivatives trading activity increased as traders and investors rushed to capitalize on opportunities to hedge and participate in the selling momentum. Unsurprisingly, the derivatives markets became the go-to venue for them to take advantage of these opportunities.

The sell-off provided ample opportunities for both shorter-term traders and longer-term investors alike to acquire crypto assets at a significant discount. 

Insurance funds suffered significant losses 

Crypto derivatives exchanges witnessed one of its highest liquidations ever as Bitcoin recorded one of its worst trading days in history. An estimated $1 billion in long positions were liquidated across major exchanges as markets capitulated.

As liquidations were triggered, Binance Futures’ insurance fund was activated to absorb losses from its users. The fund used more than 50% of its resources to protect users from auto-deleverage liquidations (ADLs), resulting in a decline in its USDT reserves from 12.8 million to 6.2 million USDT. 

Foreseeing more volatility ahead, Binance Futures injected more reserves totaling 5 million USDT to protect more users from auto-deleverage liquidations (ADL). Furthermore, Binance Futures managed to avoid any large ADL events as liquidation losses were adequately covered by its insurance fund.

Unlike other insurance funds, the Binance Futures’ insurance fund is used for what it was intended. The fund accepts risk and positions in the event of sizable liquidations to ensure that clients do not receive auto-deleverage liquidations (ADLs).

Chart 6 - Binance Futures insurance funds lost 50% of its value 

Source: Binance Futures

Similar to Binance, Deribit’s insurance fund was nearly vaporized overnight as a result of the crash. In three days, Deribit’s fund fell by 53% from 391 BTC to 183 BTC. 

On the contrary, insurance funds on other major exchanges such as OKex, Huobi and Bitmex seem under-utilized despite massive amounts of liquidations reported across these exchanges. 

Chart 7 - Net outflows from insurance funds across other crypto exchanges

Source: Binance Futures

As the market capitulation unfolds on 12 and 13th of March, these exchanges did not report any significant outflows from their respective insurance funds (refer to chart). 

Ultimately, the purpose of an insurance fund is to protect users. The Binance Futures’ insurance fund is a dedicated resource to ensure that bankrupt traders do not suffer from adverse losses and the profits of winning traders are paid out in full. Therefore, it is crucial to maintain the fund as a consumer protection feature and use it as intended.

Final Thoughts

In extremely volatile markets, exchanges must provide a seamless trading experience for users as any technical and congestion issues may add more panic into the markets, as we witnessed in the past week.

In addition, cryptocurrency exchanges must ensure that robust risk management mechanisms are in place to provide a reasonable level of assurance to protect users. As such, it is crucial to maintain safety nets such as insurance funds that are consumer-protection driven and used as intended.

Looking ahead, the crypto-derivatives market could continue to register strong volumes and display high volatility as uncertainties across the global economy persist.

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