Open Interest: A Key Indicator for Crypto Traders

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25 Jun 2023

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If you are interested in trading crypto derivatives, such as futures and options, you may have come across the term open interest. But what does it mean and why is it important for crypto traders?

In this article, we will explain what open interest is, how it differs from trading volume, how to interpret it, and how to use it to gain insights into the crypto market.

What Is Open Interest?

Open interest (OI) is a metric that measures the number of active derivatives contracts for a specific crypto asset, such as Bitcoin or Ethereum. It represents the total number of contracts that have not been closed, expired, or exercised by the end of the day. It can be seen as an indicator of the flow of money into or out of the crypto derivatives market.

For example, if Alice buys 10 Bitcoin futures contracts and Bob sells 10 Bitcoin futures contracts, the open interest of Bitcoin futures increases by 10. If Alice closes her position by selling 5 contracts and Bob closes his position by buying 5 contracts, the open interest of Bitcoin futures decreases by 10. If Alice buys another 5 contracts and Bob sells another 5 contracts, the open interest of Bitcoin futures remains unchanged.

Open interest can be calculated for different types of derivatives contracts, such as perpetuals, futures, and options. Perpetuals are contracts that have no expiry date and mimic the spot price of the underlying asset. Futures are contracts that oblige the buyer and seller to exchange the underlying asset at a predetermined price and date in the future. Options are contracts that give the buyer the right, but not the obligation, to buy or sell the underlying asset at a predetermined price and date in the future.

How Is Open Interest Different from Trading Volume?

Trading volume is another metric that measures the amount of trading activity in a market. It represents the total number of contracts that have been traded within a given period of time, such as a day or an hour. It can be seen as an indicator of the liquidity and popularity of a market.

For example, if Alice buys 10 Bitcoin futures contracts and Bob sells 10 Bitcoin futures contracts, the trading volume of Bitcoin futures increases by 10. If Alice closes her position by selling 5 contracts and Bob closes his position by buying 5 contracts, the trading volume of Bitcoin futures increases by another 10. If Alice buys another 5 contracts and Bob sells another 5 contracts, the trading volume of Bitcoin futures increases by another 10.

Unlike open interest, trading volume does not distinguish between opening and closing positions. Therefore, it does not reflect the net change in market participation or sentiment. Trading volume can also be influenced by factors such as market manipulation, wash trading, or arbitrage.

Why Is Open Interest Important for Crypto Traders?

Open interest can provide valuable information for crypto traders who want to understand the current state and direction of the crypto market. By analyzing open interest data, traders can gain insights into:

Market sentiment: Open interest can indicate whether traders are bullish or bearish on a crypto asset. Generally speaking, a rising open interest means that more traders are entering new positions or adding to their existing positions, which implies that they expect the price to move in their favor. Conversely, a falling open interest means that more traders are closing their positions or reducing their exposure, which implies that they expect the price to move against them.
Market momentum: Open interest can indicate whether a price trend is strong or weak. Generally speaking, a rising open interest along with a rising price means that there is strong buying pressure and momentum behind the uptrend. Conversely, a rising open interest along with a falling price means that there is strong selling pressure and momentum behind the downtrend. On the other hand, a falling open interest along with a rising or falling price means that there is weak momentum and conviction behind the trend.
Market volatility: Open interest can indicate how volatile a market is likely to be. Generally speaking, a high open interest means that there is a lot of money at stake and a lot of potential for large price movements. Conversely, a low open interest means that there is less money at stake and less potential for large price movements.

How to Analyze Open Interest Data for Crypto Trading?

To analyze open interest data for crypto trading, traders need to access reliable sources of data and use appropriate tools and methods. Some of the sources of open interest data for crypto derivatives are:

CoinGlass: aggregates open interest data for top coins across major exchanges
CryptoQuant: provides open interest data for BTC/USD trading pairs on derivative exchanges
The Block: provides advanced charts and data for open interest, trading volume, and funding rates

Some of the tools and methods that traders can use to analyze open interest data are:

Charts: Traders can use charts to visualize the changes in open interest over time and compare them with the changes in price and volume. Traders can also use technical indicators, such as moving averages, trend lines, or support and resistance levels, to identify patterns and signals.
Tables: Traders can use tables to compare the open interest data across different crypto assets, exchanges, or contract types. Traders can also use filters, such as expiry date, strike price, or delta, to narrow down their analysis.
Ratios: Traders can use ratios to measure the relationship between open interest and other metrics, such as trading volume, market capitalization, or price. Some of the common ratios that traders use are:
- Open Interest/Volume Ratio: This ratio measures how much open interest is generated per unit of trading volume. A high ratio means that there is more open interest than trading volume, which implies that traders are holding their positions longer and expecting larger price movements. A low ratio means that there is less open interest than trading volume, which implies that traders are closing their positions faster and expecting smaller price movements.
- Open Interest/Market Cap Ratio: This ratio measures how much open interest is generated per unit of market capitalization. A high ratio means that there is more open interest than market capitalization, which implies that traders are using more leverage and taking more risk. A low ratio means that there is less open interest than market capitalization, which implies that traders are using less leverage and taking less risk.
- Open Interest/Price Ratio: This ratio measures how much open interest is generated per unit of price. A high ratio means that there is more open interest than price, which implies that traders are more interested in the crypto asset and expecting higher returns. A low ratio means that there is less open interest than price, which implies that traders are less interested in the crypto asset and expecting lower returns.

Closing Thoughts

Open interest is a key indicator for crypto traders who want to understand the dynamics of the crypto derivatives market. By tracking and analyzing open interest data, traders can gain insights into the market sentiment, momentum, and volatility of a crypto asset.

However, open interest is not a standalone indicator and should be used in conjunction with other metrics, such as price, volume, funding rates, and implied volatility. Moreover, traders should be aware of the limitations and risks of trading crypto derivatives, such as leverage, liquidation, counterparty risk, and regulatory uncertainty.