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Since May 2022, the Bitcoin (BTC) margin markets on the Bitfinex exchange have been plagued by an unusually high open interest of over $2.7 billion. This information alone should raise a red flag, especially in light of Bitcoin’s price decline from $39,000 to less than $25,000 during the same period.
Traders seeking to leverage their cryptocurrency position had borrowed over 105,000 Bitcoin. Currently, the cause of this anomaly is unknown, as well as the number of entities involved in the trade.
Cheap borrowing favors high demand
Bitfinex’s sub-0.1% annual rate may be a contributing factor to the size of the Bitcoin lending market. To date, this has been the norm and it creates enormous incentives for borrowing, even if there is no current need. There are few traders who would turn down such a ridiculously inexpensive leverage opportunity.
Margin borrowing can be used to take advantage of arbitrage opportunities, where a trader exploits price discrepancies between different markets. For example, borrowing Bitcoin on margin allows a trader to take a long position in one market and a short in another, profiting from the price difference.
To understand how Bitcoin borrowing can be used to profit on derivatives markets, including those outside of Bitfinex, one must understand the distinction between futures contracts and margin markets. The margin is not a derivative contract, so the trade occurs on the same order book as spot trading. In addition, unlike futures, margin longs and shorts are not always in balance.
For example, after purchasing 10 Bitcoin using margin, the coins can be withdrawn from the exchange. Naturally, the trade, which is typically based on stablecoins, requires some form of collateral or a margin deposit.
If the borrower fails to return the position, the exchange will liquidate the margin in order to repay the lender.
Additionally, the borrower must pay interest on the BTC acquired with a margin. The operational procedures vary between centralized and decentralized exchanges, but the lender typically determines the interest rate and duration of offers.
There was a 12,000 BTC margin decline in a single trade
Historically, Bitfinex margin traders have been known to move large margin positions quickly, indicating the participation of whales and large arbitrage desks. In the most recent instance, on March 25, those investors reduced their long positions by 12,000 BTC in minutes.
Bitfinex BTC margin longs, in BTC contracts. Source: TradingView
Notice how significant the decrease was, despite the fact that it had no effect on the Bitcoin price. This supports the theory that such margin trades are market-neutral because the borrower is not leveraging their positions with the proceeds. Most likely, there is some arbitrage involving derivatives instruments.
Traders should cross-reference the data with other exchanges to confirm that the anomaly affects the entire market, given that each exchange has distinct risks, norms, liquidity and availability.
OKX, for example, provides an indicator for margin lending based on the stablecoin/BTC ratio. Traders can increase their exposure on OKX by borrowing stablecoins to purchase Bitcoin. Bitcoin borrowers, on the other hand, can only wager on the price decline.
OKX stablecoin/BTC margin lending ratio. Source: OKX
The above chart shows that OKX traders’ margin lending ratio has been stable for the past week near 30, indicating that professional traders’ long-to-short bets have not changed. This data supports the theory that Bitfinex’s decline is due to an arbitrage close unrelated to Bitcoin price movement.
Related: US government plans to sell 41K Bitcoin connected to Silk Road
Recent crypto bank closures could have triggered the movement
Another possibility for the sudden decrease in margin demand is the $4 billion in deposits associated with the now defunct Signature Bank and its digital banking business. Crypto clients were told to close their accounts by April, according to a Bloomberg report.
While New York Community Bancorp (NYCB) purchased the majority of Signature Bank’s deposits and loans on March 19, the deal with the FDIC did not include crypto-related accounts.
If those whales are forced to close their banking accounts, they will most likely reduce their arbitrage positions, including those in margin markets. For the time being, all assumptions are speculative, but one thing is certain: the 12,000 BTC long margin reduction at Bitfinex had no effect on Bitcoin prices.
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This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.