Over the past month, a large amount of capital has been wiped out of the crypto sector. As prices have been plunging, there has been a severe liquidity crisis across major firms and investors in the space.
What Happened: As a result of major capital in-flow over 2020 and 2021, the crypto and DeFi space had accumulated large amounts of leverage. As cryptocurrency prices fell, Bitcoin (CRYPTO: BTC) dropped from its all-time high of over $68,000 to the $20,000 range. Ethereum (CRYPTO: ETH) has also fallen from its heights of $4,808 to $1,151 currently.
Therefore, there has been a major deleveraging across the sector. According to Glassnode, as of June 26, Bitcoin's Futures Estimated Leverage Ratio across all exchanges sits at 0.226.
Why It’s Important: The estimated leverage ratio indicates the amount of leverage employed by Bitcoin users on an aggregated scale. This figure is computed by a ratio of open interest with regard to reserves.
Reserve pertains to the number of crypto tokens housed in wallets of derivative exchanges. Open interest refers to the total count of derivative contracts that are open across exchanges.
A higher estimated leverage ratio indicates a higher use of leverage in the cryptocurrency markets, signalling greater risk being taken in the market. However, when the market experiences major drawdowns, such as the latest Bitcoin crash, the leverage ratio experiences extreme volatility.
The past 18 months witnessed an extreme rise in the leverage ratio across the market, with new all-time highs being reached numerous times. As revealed by Glassnode, the Ethereum DeFi sector saw a severe deleveraging, with an outflow of $124 billion worth of capital.
The major wipe-out of leverage can be attributed to major lending positions being created during the market upturn and the fall in the value of provided collaterals, attributed to the falling token prices.
Thus, as DeFi retail investors experience unrealized profits of staked tokens, token prices continue their downfall, and market uncertainties heighten, the recent market crash is a signal for investors to use leverage cautiously.
