The cryptocurrency markets may be entering overheated territory, with leverage levels across both centralized and decentralized finance platforms hitting worrying highs. According to Lucas, the Head of Research at IntoTheBlock, this concerning trend could potentially set the stage for a significant market correction in the coming weeks or months.
Warning Signs In The Crypto Market
However, what is more striking is that meme tokens are not the only ones with a sudden surge in value; even large-cap assets have seen an increase in leverage relatively fast. This pattern is visible in the derivatives market, where long positions have reached their highest prices since 2021.
For instance, the amount that buyers of Bitcoin perpetual swaps pay to those going short is at its highest since October 2021. Specifically, funding rates on Binance and Bybit reached staggering levels of 0.06% and 0.09% recently, paid every 8 hours. These fees translate to an annualized cost of 93% and 168%, respectively, to go long on Bitcoin. Such abnormally high funding rates indicate a market heavily skewed towards the long side despite the potential for ETF inflows to temporarily buoy spot prices.
However, the high leverage extends beyond centralized exchanges, as loans on DeFi platforms have also rapidly accelerated. Indeed, the aggregate amount of debt issued through Aave v3 on Ethereum has more than doubled year-to-date in 2024. As Bitcoin reaches new all-time highs, crypto investors have begun seeking leverage against their holdings, with the amount of wrapped Bitcoin (WBTC) supplied to Aave increasing by more than 10,000 BTC (approximately $700 million) so far this year.
Consequently, as demand for leverage has significantly increased, so have rates in DeFi. Users lending their assets to lending protocols are being handsomely rewarded for the market’s increased appetite for leverage, with some protocols offering annual percentage yields (APYs) exceeding 15% for supplying stablecoins.
While the resilience of today’s market, sustained by continuous spot ETF inflows, cannot be understated, the high borrow costs exhibited in both derivatives and DeFi could precipitate short-term pain for crypto markets. If markets eventually stop rallying, leveraged long positions begin to lose due to borrowing costs, potentially forcing many traders to sell their positions. This could lead to a significant correction as the amount of leverage in the system gets reset.
Although it is difficult to predict precisely when such a correction might occur, the increasingly high borrowing costs should serve as a cautionary signal for crypto investors. Historical precedent offers a sobering lesson – in early 2021, funding rates remained elevated for several months before a violent, leverage-driven unwinding sparked a 55% price crash across crypto markets in the second quarter. While this year’s rally has been buoyed by sustained institutional inflows, any slowdown in that momentum could expose the overleveraged market to significant downside risks.
Related Reading | Bitcoin ETFs Witness Unprecedented Demand, Fueling Price Speculation