Crowded trade? Retail hasn’t been this long on BTC, ETH, SOL, XRP in over a year

The cryptocurrency market’s capitalization metric has been trading within a relatively narrow upward channel for the past 10 weeks. This indicates that bullish momentum has remained intact despite recently failing to break above the $1.7-trillion market cap resistance.

In December, Bitcoin’s (BTC) price made 20-month highs above $44,000, and Ether’s (ETH) upswing was stropped at $2,400. Some analysts argue that the excessive demand for leveraged longs (buying) will trigger a correction, but is that really the case?

Regardless of whether the ongoing bullishness has been driven by the expectation of a spot Bitcoin exchange-traded fund (ETF) approval by March, the odds of cascading liquidations exist when traders heavily rely on futures markets.

This is why analysts monitor leverage demand to assess the risk of a sell-off driven by derivatives markets. Let’s take a closer look at how this is done.

Pro traders are (moderately) bullish on Bitcoin

To determine how whales and market makers are positioned, one should analyze the Bitcoin futures premium, also known as the basis rate.

Professional traders prefer monthly contracts due to the absence of a funding rate, which causes these instruments to trade 5%–10% higher relative to regular spot markets, justifying the longer settlement period.

Data reveals that the three-month Bitcoin futures premium has remained above the 10% neutral threshold since Dec. 1, indicating excessive demand for long positions.

Still, the current 15% premium is somewhat expected, given that BTC’s price gained 11.5% in December alone. On the other hand, those willing to bet on a price decline currently benefit from a healthy cushion as the futures contract is trading $1,800 above the spot price.

The futures premium necessarily vanishes on the expiration date (March 30) for the depicted three-month contract. Consequently, arbitrage desks and market makers are incentivized to short (sell) the futures and hedge the position by buying spot Bitcoin. This trade, known as “cash and carry,” resembles a fixed-income market structure.

BTC, ETH, SOL, XRP funding rates at yearly highs

On the other hand, retail traders’ preferred instrument for leverage is the perpetual contract, also known as an inverse swap. These contracts have an embedded fluctuating rate, usually charged every eight hours. So, their price tends to match the spot markets instead of the typical premium found in monthly contracts.

In a sense, it’s more straightforward for traders, but at the same time, it introduces the uncertainty of variable funding costs.

A positive funding rate indicates that long positions (buyers) demand more leverage, while the opposite occurs when short positions (sellers) require additional leverage, causing the funding rate to turn negative.

Notice how the weekly funding rate reached a one-year high, ranging from 1% to 1.2% for the top five coins, including XRP (XRP) and Solana’s SOL (SOL), in terms of futures’ open interest.

Is the crypto market overheated?

Typically, excessive optimism can cause such indicators to remain above 2% for a couple of weeks or even longer, unless the asset price faces an unexpected correction or a period of price stabilization.

On the other hand, during bear markets, the funding rate can remain negative as long as the demand for short positions exceeds the use of leverage for long positions.

Related: India takes steps to block Binance, Huobi, other global crypto exchange URLs

While the current 1.2% average weekly funding rate may sound excessive, most retail traders are looking for short-term gains, perhaps a couple of weeks until the spot Bitcoin ETF decision. Therefore, most of them are capable of absorbing the cost — if they are even aware of its existence.

Investors’ greed and their inexperience in calculating the funding rate cost create a perfect environment for exorbitant fees during bull runs. This explains why there’s no real cap on what can be deemed excessive in terms of the funding rate, at least from a short-term perspective.

Judging by the three-month futures premium, there’s nothing out of the ordinary happening with cryptocurrency futures. In other words, there is no impending risk of mass liquidation due to excessive leverage by retail traders using perpetual contracts.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.