Crypto’s Growing Leverage Flashes an Early Warning Sign
Funding rates and DeFi loans signal caution
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This week we focus on the signs of greed developing in crypto markets. We dive into centralized derivatives and decentralized lending protocols to evaluate the amount of leverage in crypto, analyzing the consequences it may bring to crypto investors in the short to medium-term.
Network Fees — Sum of total fees spent to use a particular blockchain. This tracks the willingness to spend and demand to use Bitcoin or Ether
- Bitcoin fees declined as BRC-20 activity dropped
- Fees on Ethereum set a yearly high for the second consecutive week, with Uniswap leading in terms of gas consumption
Exchanges Netflows — The net amount of inflows minus outflows of a specific crypto-asset going in/out of centralized exchanges
- $700M worth of BTC was withdrawn from centralized crypto exchanges as spot ETFs continue setting records
- ETH saw relatively lower net outflows from CEXs, lagging behind Bitcoin
Crypto’s Growing Leverage Flashes an Early Warning Sign
The crypto market is showing signs of being overheated. The average 90-day return for the top 20 crypto-assets (excluding stablecoins) listed on IntoTheBlock is of 103%. The worst performer of this top 20 has rallied “only 28%”.
Not only are meme tokens rocketing left to right, but the amount of leverage behind large cap assets has also quickly accelerated. This is evident in derivatives markets where borrow costs to go long have reached their highest since 2021.
Funding Rates Reach Highest Levels Since 2021 — The amount that buyers of Bitcoin perpetual swaps pay those going short is at its highest since October ‘21
- Funding rates on Binance and Bybit reached levels of 0.06% and 0.09% yesterday, paid every 8-hours
- These fees translate to an annualized cost of 93% and 168% in order to go long Bitcoin
- The abnormally high funding rates are indicative of a market that skews very heavily on the long side
- While ETF flows may continue carrying spot prices for the moment, the overly bullish positioning in derivatives posts a warning sign for the market
The high leverage is extending beyond centralized exchanges, with loans on DeFi quickly accelerating.
DeFi Loans Double in 2024 — The aggregate amount of debt issued through Aave v3 on Ethereum has increased by a factor of 2.14 year-to-date
- As Bitcoin reaches new all-time highs, crypto investors have begun seeking leverage against their holdings
- The amount of wrapped Bitcoin (WBTC) supplied to Aave has increased by more than 10,000 BTC (~$700M) so far in 2024
As demand for leverage has significantly increased, so have rates in DeFi.
15%+ APY for Supplying Stablecoins to Lending Protocols — Users lending their assets to lending protocols are being handsomely rewarded for the market’s increased leverage appetite
- On March 10, MakerDAO implemented an accelerated proposal, tripling borrow costs and the DAI savings rate on the protocol
- Despite the substantial “rate hike”, the amount of loans on Maker have actually increased by 5% since the proposal, demonstrating the seemingly inexorable demand for leverage at the moment
- Part of this demand can be linked back to the high funding rates discussed at the beginning, where a market-neutral strategy going long spot and short derivatives can net out nearly 70% returns annualized
- Ethena, a new protocol executing this trade on behalf of users, has managed to scale to over $1B in deposits, leading to the high leverage in centralized derivatives to manifest itself in DeFi more than ever
The Great Unwinding — The crypto market is likely to experience a significant correction as leveraged positions get paid back or are liquidated
- The high borrow costs exhibited in both derivatives and DeFi could cause short-term pain for crypto markets
- When markets eventually stop rallying, leveraged longs begin to lose due to borrowing costs, forcing many traders to sell positions
- In early 2021, funding rates sustained at slightly higher levels than today’s for several months, but ended up preceding a 55% crash in Q2 as leverage was violently wiped out
Today’s market may be more robust, being sustained by continuous spot ETF inflows. However, if these slow down — either naturally or due to some unforeseen event — it is likely that crypto may experience a 20%+ correction as the amount of leverage in the system gets reset. While it is difficult to time when exactly this will come, the increasingly high borrow costs should signal caution for crypto investors.
