Crypto Avalanche: Ethereum Futures Premium Hits 1-Year High

Ether (ETH) has experienced a 14.7% decline since its peak of $2,120 on April 16, 2023. Interestingly, despite this bearish sentiment, two derivatives metrics suggest that investors have not felt this optimistic in over a year. This discrepancy prompts an investigation into whether the recent bullishness is a broader response to Bitcoin (BTC) breaking above $34,000 on Oct. 24.

One potential explanation for the enthusiasm among investors using ETH derivatives is the excitement surrounding the potential approval of a spot Bitcoin exchange-traded fund (ETF) in the United States. According to analysts from Bloomberg, the amendments to the spot Bitcoin ETF proposals can be seen as a “good sign” of progress and impending approvals. This could potentially drive the entire crypto market to higher price levels.

U.S. SEC Chair Gery Gensler’s comments in 2019 provide some context. At the 2019 MIT Bitcoin Expo, Gensler noted the SEC’s “inconsistent” position at the time, having denied multiple spot Bitcoin ETF applications, while futures-based ETF products that do not involve physical Bitcoin had been in existence since December 2017.

Another potential factor in the optimism of Ethereum investors using derivatives may be the pricing of the Dencun upgrade scheduled for the first half of 2024. This upgrade is set to improve data availability for layer-2 rollups, thus reducing transaction costs. Moreover, the upgrade will prepare the network for the future implementation of sharding (parallel processing) as part of the blockchain’s “Surge” crypto avalanche.

Ethereum co-founder Vitalik Buterin highlighted in his Oct. 31 statement that independent layer-1 projects are gradually migrating and potentially integrating as Ethereum ecosystem layer-2 solutions. Buterin also noted that the current costs associated with rollup fees are not acceptable for most users, particularly for non-financial applications.

Challenges for Ethereum competitors

Ethereum competitors are facing challenges as software developers recognize the costs of sustaining a complete record of a network’s transactions. For instance, the popular blockchain explorer tool SnowTrace for Avalanche (AVAX) declared its shutdown due to the high costs.

Phillip Liu Jr., head of strategy and operations at Ava Labs, highlighted the difficulties users face in self-validating and storing data on single-layer chains. This leads to a need for substantial processing capacity, which can cause unexpected issues.

For example, on October 18, the Theta Network team encountered an “edge case bug” after a node upgrade, resulting in a halt in blocks production on the main chain for several hours. Similarly, layer-1 blockchain Aptos Network (APT) experienced a five-hour outage on October 19, halting deposits and withdrawals on exchanges.

In essence, the Ethereum network may not have a solution to its high fees and processing capacity bottlenecks at the moment. Nevertheless, it has an eight-year history of continuous upgrades and improvements towards that goal with only a few major disruptions.

Assessing bullish sentiment in ETH derivatives markets

In spite of Ethereum’s 14.7% drop from its $2,120 peak in April, it is essential to study the bullish sentiment among ETH traders in the derivatives markets. The Ether futures premium, which measures the difference between two-month contracts and the spot price, has hit its highest level in over a year. The annualized premium, or basis rate, is usually between 5% to 10%.

Data suggests a growing demand for leveraged ETH long positions, as the futures contract premium jumped from 1% on Oct. 23 to 7.4% on Oct. 30, surpassing the neutral-to-bullish threshold of 5%. This surge was preceded by a 15.7% rally in ETH’s price over two weeks.

The 25% delta skew in Ether options is another indicator to consider. When traders anticipate a drop in Ether’s price, the skew metric rises above 7%. On the other hand, a negative 7% skew is usually seen when the crypto is in a phase of excitement. The Ether options 25% delta skew reached a negative 16% level on Oct. 27, the lowest in over 12 months. This means that protective put (sell) options were trading at a discount, a sign of excessive optimism. The current 8% discount for put options is a complete turnaround from the 7% or higher positive skew that persisted until Oct. 18.

The drivers behind the bullish sentiment among Ether investors in derivatives markets are unclear. It could be due to the anticipation of approval for Ether spot ETF instruments following Bitcoin’s potential approval, or the planned upgrades that aim to reduce transaction costs and eliminate the competitive advantage of other blockchain networks like Solana (SOL) and Tron (TRX).