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Was the ETH price flash crash to $3,180 triggered by excessive leverage?


Ether (ETH) price gained 14% between Feb. 26 and Feb. 28, reaching the highest level in almost two years at $3,484, but the movement coincided with a surge in the cost for bullish leverage positions, which is somewhat concerning. Given that Ether experienced a flash crash down to $3,180 on Feb. 28, some investors believe that excessive optimism driven by fear of mis FOMO has increased the risk of cascading liquidations.

Not all Ether leverage demand is related to YOLO bets

Firstly, one needs to note that some traders might need temporary leverage while they raise cash, either by selling other assets or waiting for deposits to kick in. Such movements are common in the heat of the market, even for professional arbitrage desks, and cause the funding rate to soar, which can last for a couple of days or even weeks.

Some analysts argue that the reason behind investors' increased optimism toward Ether’s price is the upcoming Dencun hard fork, scheduled for March 13. The upgrade introduces several improvements, including proto-danksharding, which aims to reduce layer-2 transaction fees. The expected upgrade would greatly reduce the data registry cost for Ethereum network's preferred scaling solution, rollups.

Ethereum’s leading decentralized exchange (DEX), Uniswap, has already announced plans to launch a v4 implementation, so one should expect users to really experience benefits following the Dencun upgrade. Furthermore, analyst TrustlessState on X social network expects inscription costs on the network to drop by 90%, which should be “fuel to an already roaring meme economy.”

Regardless of how one values inscriptions or the potential for this market, their impact on network costs and uptime are undeniable. For instance, Avalanche, a blockchain that claims to support much higher scalability versus Ethereum, experienced an outage on Feb. 23 due to excessive demand in the mempool for inscriptions, according to an Ava Labs representative.

Scalability has been Ethereum’s Achilles heel for a long time given that the average 7-day transaction fee stood at $4 or higher for the past four months, but that was not an impediment for network deposits (TVL) to reach the highest level since July 2022 at ETH 30.5 million.

Ethereum total value locked (TVL), ETH. Source: DefiLlama

The growth in deposits reflects the emergence of new decentralized finance (DeFi) industries such as liquid staking, like Lido, EigenLayer, and Rocket Pool, but also the successful strategy of interoperability protocols, including Summer.fi and Instadapp. In short, investors' appetite for ETH also spurs from the growing demand for the network’s decentralized applications.

Temporary spikes in Ether funding rate is not unusual

To determine whether excessive leverage drove Ether’s recent rally toward $3,400, one should analyze ETH derivatives markets. Perpetual contracts, also known as inverse swaps, include an embedded rate that is typically recalculated every eight hours.

A positive funding rate indicates increased demand for leverage among long (bull) positions, while a negative rate signals the need for higher leverage being used by shorts (bear).

Ether perpetual futures 8-hour % funding rate, 2023. Source: Laevitas.ch

On Nov. 9, 2023, the Ethereum funding rate soared above 5% per month as Ether's price rallied 13.3%, but the cost of leverage declined to 2% the next day, so whatever caused the rate spike was quickly offset. However, longer periods of high leverage costs for longs typically indicate unhealthy bullishness.

Related: Matrixport warns of market euphoria, correction after Bitcoin’s $60K milestone

The unexpected volatility on Feb. 28 triggered $102 million in ETH forced liquidations, with longs representing $66 million. The movement also increased the leverage of previously existing bullish positions since their margin was eroded as Ether’s price crashed to $3,180.

Ether perpetual futures 8-hour % funding rate, 2024. Source: Laevitas.ch

Notice how Ether’s present 0.06% funding rate – equivalent to 5.6% per month – is far higher than the previous couple of weeks. Such a level is usually deemed unsustainable, but only if it holds ground for a relatively long period, maybe a couple of weeks.

Thus, presently, ETH longs are running the risk of liquidations, but attributing the rally to excessive leverage is incorrect since the indicator was relatively calm up until Feb. 27, after Ether’s price had gained 42% in the previous 30 days.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.



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