What Information Does Open Interest Convey?
Traders are always searching for information to get an edge in the market. The most valuable information is one that provides insights into what other traders are doing - Open Interest offers this information if you know how to interpret it. By understanding open interest and its impact on crypto prices, it can help you make better-informed trading decisions.
Understanding Open Interest
Open interest and volume are related concepts. Volume accounts for all contracts that have been traded in a given period. On the other hand, open interest considers the total number of open positions held by market participants at any given time. Regardless of position, open interest is calculated by adding up all opened trades (long and short) and subtracting away trades that have been closed.
Let’s consider a scenario where traders - John, Alice, and Bob opens a position in BTCUSDT perpetual futures, simultaneously, Sam closes his position - let’s study how this impacts open interest. Table 1 shows how open interest changes as a result of the traders’ activities.
Table 1 - Changes in open interest as a result of trading activity
As shown in the table, open interest increased from 3 to 15, as traders open new positions. Conversely, open interest declines as existing positions are closed. The above scenario illustrates how open interest changes based on the number of daily open contracts.
Why does the open interest data matter?
In traditional futures markets, traders closely monitor changes in open interest. Analysts and traders typically use the open interest as an indicator to determine market sentiment and the strength behind price trends.
Open interest indicates capital flowing in and out of the market. As more capital flows into a futures contract, open interest increases. Conversely, more capital flows out, it declines. Therefore, increasing open interest is a confirmation of a bull market, whereas decreasing open interest signals a bear market.
Typically, traders track the changes in price, volume, and open interest to analyze the prevailing market sentiment. Table 2 shows an interpretation of market behavior as a result of changes in the factors above.
Table 2 - Interpretation of market behavior as price, volume, and open interest changes
Open interest is an important signal of market behavior and may provide clues to market direction. Thus, traders often incorporate these factors into their analysis of price trends and momentum.
Open interest across crypto-futures markets
In the crypto-markets, volume and open interest are fragmented across major native exchanges. Thus, analyzing open interest across these exchanges provides a macro view of investor’s sentiment on widely traded crypto assets. Chart 1 displays the aggregated BTC futures open interest across major exchanges.
Chart 1 - Open interest across major exchanges
Source: Skew.com, Data from 1st to 31st January 2020
On the whole, open interest increased from $2.5 billion on January 1st to $4 billion by January 31st. Presently, open interest in BitMEX, OKex, and Huobi dominate across the industry, with $1.4,$ 1.2, $0.7 billion of open interest respectively - adding up to 80% of the industry. Meanwhile, newcomers like Binance Futures have recorded fast-growing open interest across all of its crypto futures offerings.
In January, the general increase in open interest coincides with a recovery in BTC perpetual markets as prices rallied more than 30%. Correspondingly, its open interest increased by 60% - double the net change of perpetual prices. This clearly shows the growing optimism of BTC holders as its bullish trend is well-supported by investors.
Chart 2 - Aggregate open interest vs. BTC perpetual markets
Source: Binance Futures, Data from 1st to 31st January 2020.
The growing open interest on Binance Futures
In its fifth month of operations, Binance Futures has seen steady growth in open interest across Bitcoin and Altcoins perpetual markets. On the whole, its open interest doubled since the beginning of the year from USDT 137 to USDT 290 million. By January 12th, open interest on Binance Futures reached the $200 million mark.
In BTC perpetual markets, open interest grew 56% since January 1st. A growing open interest tends to reflect greater liquidity for the contract. Therefore, traders on Binance Futures are more likely to get their orders filled at an acceptable price.
Chart 3 - Open interest in Bitcoin perpetual contract
Source: Binance Futures, Data as of 31st January 2020.
Since the inception of 8 Altcoin perpetual contracts in January, open interest on Binance Futures has proliferated. Collectively, open interest across Altcoin perpetual markets has grown from under USDT 20 million on January 1st to USDT 75 million - expanded more than 250% in a single month.
With growing open interest for both Bitcoin and Altcoins perpetual markets, traders on Binance Futures may enjoy better liquidity as market participation grows. This means that traders can transact orders efficiently and quickly with little or no price impact.
Chart 4 - Open interest across altcoin perpetual markets
Source: Binance Futures, Data as of 31st January 2020.
In the Altcoin perpetual markets, open interest on widely traded contracts like ETHUSDT and BCHUSDT dominate 29.6% and 19.6% respectively. New offerings like ETCUSDT have grown in popularity within two weeks since its inception, with open interest growing over USDT 10 million, 13.8% of Binance Futures’ Altcoin open interest markets.
In the last 3 months, open interest on Binance Futures, specifically, BTC perpetual contracts have grown tremendously. As such, its open interest has narrowed the gap with traditional exchanges like CME. Chart 4 shows the ratio of open interest on CME Bitcoin Futures to Binance Futures (BTCUSDT).
Chart 5 - Open interest ratio on CME Bitcoin Futures to Binance Futures (BTCUSDT).
Source: CME, Binance Futures. Data from November 1st 2019 to January 31st 2020.
As shown in Chart 4, CME’s open interest was 2.8 times larger than Binance Futures at the start of November 2019. However, CME’s dominance gradually declined as Binance Futures gained a foothold in the crypto-derivatives industry. Subsequently, open interest on Binance Futures (BTCUSDT) briefly surpassed CME in the last week of December 2019, recorded USDT 136 million in open interest vs. $117 million on CME. The ratio suggests that more traders are choosing Binance Futures as their preferred platform over traditional exchanges.
The Bottom Line
Many analysts believe that interpreting changes in open interest can provide valuable information about the market. For example, if open interests are increasing along with prices and volume, it might indicate a bull trend. Open interest can help traders get a sense of whether crypto markets are strengthening or weakening. It can also be used to identify trading opportunities you might otherwise overlook.
In crypto markets, a growing open interest tends to reflect increasing capital inflows and market participation. Thus, traders can benefit from greater market liquidity on both futures as well as their corresponding spot markets. As such, traders should closely monitor the changes in open interest and use it to advantage.