ZUBR

Bitcoin Volatility and Leverage Considerations

30 April 2020

This research has been conducted by independent research consultants Diar on behalf of ZUBR. For further information on the report, contact the author Fadi Aboualfa by email.

Bitcoin spot trading has become a drop in the bucket compared to the overall volume traded on the market that is now heavily tilted to futures and leveraged products. From equities to commodities, leverage has become a staple tool used to increase the potential upside with capital limitations.

But Bitcoin traders face a heightened risk of liquidation due to its volatile nature that is yet to be tamed by a growing market and apparent liquidity.

ZUBR delves into the potential upside as well as the downside of leveraged trading. We assess the overall trader and market risks taken with high margins that prove to cause cascading liquidations, toppling cryptocurrency markets along with it during periods of increased volatility.

Key Take-Aways

• Bitcoin liquidations on BitMEX alone have hit nearly $25Bn in nominal value since January 2019 through till the end of March 2020. While recent price fluctuations last month stole headlines having priced out $3Bn in positions, this was only the third-highest monthly loss traders took in the past 15 months.

• Although historical data shows that Long positions have an equal opportunity as Shorts with Bitcoin price fluctuations, the lions share of liquidations are burdened by bullish traders.

• 100% of positions taken with 100x leverage would be liquidated on a day-to-day trading timeframe and not far behind with 50x leverage would have seen 99% of trades priced out. Data shows that anything from 25x leverage would be merely a flip of a coin possibility with Bitcoin volatility remaining high day-to-day.

• Hourly historical data tells a very different story when leverage is used below 25x. Data reveals that leverage used during intraday trading drops the risk of liquidation to below 3%, highlighting a useful tool to deploy capital better. Overleveraged positions, on the other hand, would turn risk management to borderline gambling.

• Volatility in 2020 has increased the likelihood of liquidations versus 2019 to date for both hourly trading frames and day-to-day. But using even 20x has shown to be low-risk with only a 1.9% of hourly trading windows being liquidated on long positions and 1.1% on shorts.

Many spot cryptocurrency exchanges have made their entry into derivative products following the rise in demand of leveraged Bitcoin trading seen on BitMEX, one of the first exchanges to offer such products.

The cryptocurrency derivates space continues to gain speed into 2020 with institutional-grade exchanges setting a new benchmark standard in market execution to the ultimate benefit of the industry and investors at large.

But massive liquidations continue to plague Bitcoin trading as collateral limits remain lax. This has lead to capital being lost at a fast pace against one of the most notoriously volatile assets. Binance has upped the ante and began offering 125x leverage on Bitcoin positions to what seemingly remains a retail investor base.

The ability of significant leveraged positions on unregulated cryptocurrency exchanges can be cause for alarm. While leverage is a traditional financial tool, data compiled and assessed by ZUBR shows that Bitcoin volatility would turn any leveraged position north of 25x to be a mere gamble.

Such high leverage allowances given by cryptocurrency exchanges in the pursuit of high-risk traders and their liquidity have led regulators worldwide to question the ultimate intention of these products hampering adoption growth to what watchdogs see as a massive risk against retail investors.

But leverage used the right way, even with a volatile asset such as Bitcoin, which can prove to be a useful tool for better capital deployment, mitigating volatility risk, and the protection of investment portfolios through hedging.

What’s happened so far?

A price plunge in Bitcoin during March saw over $1.6Bn in liquidations over two days on BitMEX alone. The majority of positions were on a bullish sentiment that ultimately went against trader positions causing deep liquidations and prices plummeting further.

As ZUBR research has previously shown, historical data indicates that the opportunity to go long is as equal to go short. However, cryptocurrency traders have levitated to bullish sentiment consistently outstripping short positions (see charts).

In 2019, despite a year of favorable recovery in Bitcoins price, liquidations amassed to nearly $20Bn, 65% of which were on long positions gone in the opposite direction. For 2020, up until the end of March, 75% of liquidations were against the bullish sentiment causing nearly $5Bn in lost nominal capital in the first quarter of the year alone. Half of the total liquidation value came from untimely long positions during the March price crash.

1: Bitcoin XBTUSD: Total Buy & Sell Liquidations on Bitmex

JavaScript chart by amCharts 3.21.15Jan2019FebMarAprMayJunJulAugSepOctNovDecJan2020FebMar0500mn1bn1.5bn2bn2.5bn3bn3.5bnJS chart by amCharts

2: Bitcoin XBTUSD: Total Buy (Short) Liquidations on Bitmex

JavaScript chart by amCharts 3.21.15Jan2019FebMarAprMayJunJulAugSepOctNovDecJan2020FebMar0200mn400mn600mn800mn1bn1.2bnJS chart by amCharts

3: Bitcoin XBTUSD: Total Sell (Long) Liquidations on Bitmex

JavaScript chart by amCharts 3.21.15Jan2019FebMarAprMayJunJulAugSepOctNovDecJan2020FebMar0500mn1bn1.5bn2bn2.5bn3bnJS chart by amCharts

4: % of Total Liquidations on Long Position Much Larger Consistently Than Short

JavaScript chart by amCharts 3.21.15Jan2019FebMarAprMayJunJulAugSepOctNovDecJan2020FebMar0102030405060708090100Average: 64% Sell LiquidationsJS chart by amCharts

100x Leverage = 100% Loss

There does come a point when leverage is no longer a risk management tool but a risk in itself. Data shows that historical day-to-day prices movements in Bitcoin using anything above 50x leverage would almost guarantee a liquidation within 24hours. 25x doesn’t fare much better either with an average of 75% chance of liquidation.

Historical data shows however that traders are positioning themselves in unfavourable overleveraged longs and shorts. Looking at price movement directions and the percentage change in price required to be liquidated on either side of the position, long or short, shows that day-to-day trading with leverage up to 10x would have less than a 20% chance of being on the losing side by the end of the day (see tables).

Day-to-Day Trading Historical Liquidation Risks (Based on Peak or Low of that Day)

Long Positions: # of Days Liquidated

Short Positions: # of Days Liquidated

Long Positions: % of Days Liquidated When Price Decreased

Short Positions: % of Days Liquidated When Price Increased

When Leverage Becomes Useful

The usefulness of leverage becomes much more evident far removed from the 100x standard that is being allowed on various cryptocurrency exchanges. Hourly price movements show that leverage can be used for potential upside with only a minimal amount of risk taken by the trader.

A trader who takes a long position adding liquidity to the market at a high 20x leverage would, as far as historical data shows, take on a risk of 1.9% of being on the wrong side of the trade. A short position, which allows for higher price differences that long trades would only see a risk of 1.1%. But a long leverage position of 100x leaves traders with a 38% being on the wrong side of the trade on the hour. This has increased in 2020 versus 2019 by nearly 28%.

Hourly Trading Liquidation Risks (Based on Peak or Low of that Hour)

4: Long Positions: % of Hours Liquidated When Price Decreased

JavaScript chart by amCharts 3.21.1520192020
JavaScript chart by amCharts 3.21.150.8%1.5%6.9%29.9%1.9%2.9%10.3%38.2%20x25x50x100x010203040JS chart by amCharts

5: Short Positions: % of Hours Liquidated When Price Increased

JavaScript chart by amCharts 3.21.1520192020
JavaScript chart by amCharts 3.21.150.3%0.8%6.7%29.7%1.1%1.9%9.8%37.2%20x25x50x100x010203040JS chart by amCharts

Gone in 60 Minutes…

While historical reference points are not an indication of future results, the similarities year-on-year are strikingly similar deviating higher only on the upper-bound of leverage. This data can serve as a reference point for traders looking to increase their potential upside using leverage while understanding and mitigating the potential risks seen with Bitcoin’s volatility.

What is clearly evident is that while leverage margins of 50x and 100x lend more potential upside, they also hand over a 1 in 4 risk of being liquidated within the hour. Such high leverage shifts liquidity market making into high-risk speculative positions unlikely to prove beneficial.

Sources: Skew, CoinAPI

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