Ether (ETH) experienced a significant price increase of 14% between February 26 and February 28, reaching its highest level in nearly two years at $3,484. However, this surge in price coincided with a rise in the cost of bullish leverage positions, which is somewhat concerning. Some investors believe that this excessive optimism, driven by fear of missing out (FOMO), has increased the risk of cascading liquidations, as evidenced by the flash crash to $3,180 on February 28.
It is important to note that not all Ether leverage demand is related to risky bets. Some traders may require temporary leverage while they raise cash, either by selling other assets or waiting for deposits to come in. Such movements are common in the market, even for professional arbitrage desks, and can cause the funding rate to soar for a few days or even weeks.
Analysts argue that the increased optimism towards Ether’s price is due to the upcoming Dencun hard fork scheduled for March 13. This upgrade will introduce several improvements, including proto-danksharding, which aims to reduce layer-2 transaction fees. The expected upgrade will significantly reduce the data registry cost for Ethereum network’s preferred scaling solution, rollups. Uniswap, Ethereum’s leading decentralized exchange (DEX), has already announced plans to launch a v4 implementation, which will further enhance user experience following the Dencun upgrade. Additionally, inscription costs on the network are expected to drop by 90%, according to analyst TrustlessState on X social network, which will fuel the already booming meme economy.
The impact of inscriptions on network costs and uptime is undeniable. For example, Avalanche, a blockchain claiming to support higher scalability than Ethereum, experienced an outage on February 23 due to excessive demand in the mempool for inscriptions.
Scalability has long been a challenge for Ethereum, with transaction fees averaging $4 or higher for the past four months. However, this has not hindered network deposits (TVL), which reached the highest level since July 2022 at ETH 30.5 million. The growth in deposits reflects the emergence of new decentralized finance (DeFi) industries, such as liquid staking, as well as the success of interoperability protocols like Summer.fi and Instadapp. In summary, the growing demand for Ethereum’s decentralized applications is driving investors’ appetite for ETH.
To determine whether excessive leverage drove Ether’s recent rally, it is important to analyze ETH derivatives markets. Perpetual contracts, also known as inverse swaps, include a funding rate that is recalculated every eight hours. A positive funding rate indicates increased demand for leverage among long positions, while a negative rate indicates higher leverage being used by shorts.
On November 9, 2023, the Ethereum funding rate spiked above 5% per month as Ether’s price rallied 13.3%. However, the cost of leverage declined to 2% the next day, offsetting the rate spike. Longer periods of high leverage costs for longs typically indicate unhealthy bullishness.
The unexpected volatility on February 28 resulted in $102 million in ETH forced liquidations, with longs representing $66 million. This movement also increased the leverage of existing bullish positions, as their margin was eroded when Ether’s price crashed to $3,180.
Presently, the funding rate for ETH is 0.06%, equivalent to 5.6% per month, which is higher than the previous couple of weeks. While this level is usually deemed unsustainable, it would need to hold for a relatively long period, possibly a couple of weeks, to be concerning. Therefore, at present, ETH longs are at risk of liquidations, but attributing the rally solely to excessive leverage is incorrect, as the indicator remained relatively calm until February 27, even after Ether’s price had gained 42% in the previous 30 days.
It is important to note that this article is for general information purposes and should not be taken as legal or investment advice. The views expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.