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On December 20, on Binance, Bitcoin experienced a sharp correction at the price of $24,295. At that level, a pullback was expected as exchange heatmaps at the time showed a mountain of sell orders above $24,000.

In the next 17 hours, the price of bitcoin dropped to as low as $21,815. Behind the 10% drop in prices is the layer-by-layer liquidation of major futures exchanges including Binance, OKEx, and Huobi.

In futures markets, both buyers and shorts borrow more money to make large trades. As an example, the standard leverage in the Bitcoin futures market is as high as 100. This means that a trader can open a $100,000 position with as little as $1,000.

If the leverage is higher, the liquidation price will be closer to the price at which the trader bought or sold Bitcoin. Therefore, if the market leverage is too high, the risk of large liquidations occurring in a short period of time is magnified.

On December 21, hundreds of millions of dollars worth of long contracts were liquidated as the price of Bitcoin fell below $22,000. Data from Bybt.com at the time showed that $474 million worth of futures contracts were liquidated within four hours.

Massive cascading liquidations create massive volatility as they force traders to either buy or sell their positions at the market within a limited time span. In the Bitcoin market on December 21, many long contract holders and buyers encountered large-scale liquidation, causing the price of Bitcoin to decline.

The most direct indicator to assess whether the futures market is biased toward the buyer or the seller is the funding rate. Futures exchanges use a system called "funding" to ensure market balance.

The system requires buyers to compensate short sellers if there are more buyers in the market, and vice versa. Therefore, if the fee rate is high, it means that there are too many buyers in the futures market, and therefore, being long Bitcoin becomes a crowded trade.

From December 20th to 21st, Bitcoin’s funding rate was particularly high, reaching 0.1% at one point. Since trade compensation is the funding rate multiplied by the entire position size, it can be costly for traders.

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Analysts at JPMorgan pointed out in a report that a slowdown in Grayscale’s capital inflows would increase the risk of a Bitcoin correction.

The analyst said that throughout 2020, institutions are behind the continued rise of Bitcoin. As LongHash previously reported, data from CME and Grayscale clearly shows that institutional interest in Bitcoin has surged in 2020.

When Bitcoin’s biggest buyer demand starts to fade, then the odds of a deep correction increase. If such a trend occurs, it is likely that the bitcoin market will see layers of liquidation and cause the price to decline, which may exacerbate the decline of bitcoin.

However, even if Bitcoin corrects as institutional demand slows, its correction period is likely to be short, the on-chain analyst said.

Ki Young Ju, CEO of CryptoQuant, noted that the risk of a pullback from whales dumping Bitcoin on exchanges has become higher. However, he said that the price of the currency after the pullback will recover quickly, which may be due to buyer demand that will offset the impact of the pullback. He explained:

"I am aware of the risk of selling because whales are active on exchanges, but I don't short BTC because the buying power is strong right now. I go long with low leverage. When the indicator 'whale inflow' reaches 2 BTC, Likely pointing to sideways or bearish. Since November, BTC has always been sideways... Even if we see some corrections, it will be sharp and recover very quickly.”

A positive trend at the macro level is that exchange outflows are decreasing, but exchange reserves for stablecoins are increasing. This suggests two things: the number of whales actively selling on exchanges may be dwindling; and capital that chooses to sit on the sidelines is starting to re-enter the cryptocurrency market.

Investors tend to store funds from selling bitcoin or other cryptocurrencies in stablecoins, such as Tether. They do this because it is easier to buy other cryptocurrencies like BTC, ETH, etc. with Tether.

Therefore, if the stablecoin reserves of major exchanges start to increase, it means that investors are flowing USD deposits back into Bitcoin and other major crypto assets through stablecoins.

In the short term, the uncertainties in the Bitcoin price cycle are grayscale. According to data from Skew, the premium of the Grayscale Bitcoin Trust reached 41%, which means that investors bought Bitcoin through Grayscale at a 41% premium to the spot price.

Grayscale's premium has risen because there are no exchange-traded funds (ETFs) in the US, and as such, the Grayscale Bitcoin Trust is the investment vehicle of choice for many institutional and accredited investors.

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