Viewpoint: When open interest OI is greater than market capitalization MC, is it a speculative signal or a liquidation risk?

Author: @agintender

Original link:

Disclaimer: This article is a reprint. Readers can obtain more information through the original link. If the author has any objections to the reprint format, please contact us, and we will make modifications as per the author's request. Reprinting is for informational sharing purposes only and does not constitute any investment advice, nor does it represent Wu's views and positions.

"Open Interest (OI) greater than Market Capitalization (MC)" is an extremely strong speculative signal. It indicates that the price discovery mechanism of an asset has shifted from the spot market to the derivatives market, creating a leveraged, fragile, self-referential system. This environment is decoupled from the fundamentals and inherently prone to violent short squeezes and cascading liquidation events.

As market liquidity returns, this type of "meme coin" will become increasingly common. This article hopes to deter those "unaware" and "itching to act" traders by interpreting this signal.

1. Basic indicators of market activities and value

Before analyzing the extreme phenomena that arise in the crypto derivatives market, it is essential to establish a precise and technical understanding of the core indicators that measure market activity and asset value. This section aims to delve into two key indicators—Open Interest (OI) and Market Capitalization (MC).

1.1 Deconstructing Open Interest (OI): A Measure of Market Game Theory

The core definition of open interest (OI) refers to the total number of derivative contracts (futures) that are not yet settled, closed, or exercised at a specific point in time. It is a cumulative indicator that reflects the total amount of active positions held by market participants at the end of each trading day.

Open interest is an effective indicator for measuring the inflow or outflow of funds in the market. An increase in open interest suggests that new funds are entering the market, which is often seen as a confirmation and strengthening of the current trend. Conversely, a decrease in open interest indicates that funds are leaving the market (i.e., positions are being closed or liquidated), which signifies that the current trend may be weakening or about to reverse. This characteristic makes open interest a superior indicator for assessing market confidence.

We can compare open interest to the market's "potential energy," while trading volume represents "kinetic energy." High open interest indicates a buildup of leveraged positions (stored potential energy). When this potential energy is released—usually manifested as a continuation of a trend or a large-scale liquidation event—it is accompanied by high trading volume (release of kinetic energy).

The accumulation of potential energy (OI) determines the scale of the final kinetic energy release (dramatic price fluctuations under high trading volume). In simpler terms, the higher the OI, the greater the buildup of energy, and the more intense the "dynamic light wave" that is ultimately unleashed.

1.2 Definition of Circulating Market Capitalization: A snapshot of the spot market value

Market capitalization is a core metric for measuring the total value of a cryptocurrency, calculated by multiplying the circulating supply of the cryptocurrency by the current market price of a single token.

Distinguishing between three different concepts of supply is crucial for understanding market capitalization:

· Circulating Supply (Circulating Supply/MC): Refers to the number of tokens that are accessible to the public and can be freely traded on the market. This is an indicator of the effective market capitalization referred to in this article.

· Total Supply (: Refers to the amount of circulating supply plus the number of tokens that are locked, reserved, or not yet issued, minus the tokens that have been verifiably destroyed.

· Max Supply ): Refers to the maximum number of tokens that may exist during the lifecycle of this cryptocurrency (for example, the max supply of Bitcoin is 21 million coins).

2. Anomaly Phenomenon Analysis: When Open Interest OI > Market Capitalization MC

When the derivatives position of an asset exceeds its circulating market value, the market enters an abnormal state. This is like a small horse pulling a large cart, using a 10m market scale to control the outcome of another 100m market game - like a bubble, dazzling and brilliant, yet sensitive and fragile.

2.1 Imbalanced Mechanism: How Derivatives Surpass Underlying Assets

The core driving force behind this imbalance phenomenon is leverage (there are also "whales" in the market using 1x leverage for real money, but this is rare and will not be discussed in this article). In the derivatives market, traders can control nominal positions far exceeding their principal with a small amount of capital. For example, a trader can control a position worth $100,000 using just $1,000 in margin with 100x leverage.

Due to the existence of leverage, even if the total margin deposited by all traders is only a small portion of the asset's market value, the notional value of the positions can easily exceed the circulating market value of the asset. For example, if a token has a circulating market value of $100m, but traders use an average leverage of 20 times and open a contract position worth $200m with only $10m of margin, then its notional position will be twice the market value. (In reality, it's not that easy to establish such a position.)

2.2 Interpretation of Signals: Speculative Bubbles, Fragile Structures, and Derivative Dominance

A signal where the open interest exceeds the market value, or the accumulation of a large open interest in a short period of time, is one of the strongest indications that the market is dominated by speculation rather than fundamental investment. It indicates that the "virtual capital" used to bet on the direction of asset prices has surpassed the actual capital holding the asset itself. This situation is often described as a "speculative bubble" or "market overheating."

A high "open interest to market capitalization ratio" reveals an extremely fragile market structure that is highly sensitive to volatility. In this structure, even a small change in spot prices can trigger a disproportionate wave of liquidations in the large derivatives market, creating a self-reinforcing negative feedback loop. In a normal market, prices reflect fundamentals.

However, in this unusual state, the internal structure of the market—namely the distribution and scale of leveraged positions—has itself become the "fundamentals" driving prices. The market no longer primarily reacts to external news, but rather to its own potential risks of forced liquidation.

At this time, the derivatives market is no longer just a hedging tool for spot positions; instead, it has become the dominant driving force behind spot prices, creating a situation where "the tail wags the dog." Arbitrageurs and market makers must conduct buy and sell operations in the spot market to hedge their risk exposure in the massive derivatives market, thereby directly transmitting the sentiment of the derivatives market to spot prices.

2.3 Position Size to Market Value Ratio: A New Indicator for Measuring Systemic Leverage

To quantify this phenomenon, we define the "open interest to market capitalization ratio" as: total open interest / circulating market capitalization.

For example, if the holding amount of ABC coin is 10m and the liquid market value is 100m, then the ratio is 0.1 (10/100).

The interpretation of this ratio is as follows: · Ratio < 0.1: Normal, healthy market. Derivatives may primarily be used for hedging. · Ratio 0.1 - 0.5: Speculative activities increase. Derivatives become an important factor influencing prices. · Ratio > 0.5: Highly speculative. The market structure becomes fragile. · Ratio > 1.0: Extreme speculation and leverage. The market is in an extremely unstable state, making it very susceptible to short squeezes and chain liquidation events. This is precisely the abnormal signal discussed in this article.

For any asset, it is crucial to continuously track changes in this ratio. A rapid rise in the ratio is a clear warning signal that leverage is accumulating and volatility is imminent. This anomaly indicates that the trading price of the asset has completely decoupled from its fundamental value, and the price has become a function of the leverage mechanism.

This situation is particularly common in assets with low circulation and a strong narrative background, KOL endorsements, and extensive media coverage, such as many new coins in this version. The initial low circulation makes the spot market easier to manipulate, while the strong narrative attracts a massive influx of speculative interest into the derivatives market, creating perfect storm conditions for the ratio to exceed 1.

3. The bubble will eventually burst: volatility, short squeezes, and cascading liquidations.

When OI > MC, it is like being in a sealed room filled with gas, where just a spark is needed to create a nameless firework - and this room is called "short squeeze."

3.1 Adding Fuel to the Fire: How Extreme Positioning Creates Conditions for Short Squeezes

High open interest indicates that a large number of leveraged long/short positions are densely distributed around certain price levels. Each of these positions has a liquidation price. The sum of these positions creates a massive potential pool of forced market orders (buy or sell) that will be triggered in succession once the price moves in an unfavorable direction.

Basic principle: Long positions profit from price increases, while short positions profit from price decreases. To close a long position, you need to sell; to close a short position, you need to buy. This is the foundation for understanding the short squeeze mechanism.

3.2 Long Squeeze ( Analysis of Long Squeeze )

A long squeeze refers to a sudden and sharp price decline that forces traders holding leveraged long positions to sell their positions to limit losses.

The mechanism is as follows: · Initial Drop: A catalyst (such as negative news or large spot sell-offs) triggers a preliminary decline in price. · Liquidation Trigger: The price reaches the liquidation level of the first batch of high-leverage long positions. · Forced liquidation: The exchange's liquidation engine automatically forces the collateral of these positions to be sold in the market, causing further downward pressure on the price. · Chain Reaction: A new round of sell-offs pushes prices even lower, triggering the liquidation of the next batch of long positions with lower leverage. This creates a domino effect known as "chain liquidation."

3.3 Short Squeeze ( Analysis of Short Squeeze)

Short squeeze refers to a sudden and sharp price increase that forces short sellers to buy back assets to cover their positions.

Its mechanism is as follows: · Initial Rise: A catalyst (such as positive news or coordinated buying) triggers an initial increase in price. · Short covering pressure: Short sellers are starting to incur losses. Some will actively buy back assets ("short covering") to limit their losses. · Liquidation Trigger: Price reaches the liquidation price of high leverage short positions. · Forced Buying: The exchange's liquidation engine forcibly buys assets in the market to close out these short positions, creating significant upward pressure. This forced buying pushes prices even higher, thereby "squeezing" more shorts, forming a powerful and self-reinforcing upward cycle.

3.4 Domino Effect: The Vicious Cycle of Chain Liquidation

Liquidation in a leveraged market is a major mechanism through which volatility is amplified. They are the culprits behind the common "long and short wick" phenomenon on cryptocurrency charts—where prices move sharply in one direction in a short time, followed by a rapid reversal after liquidation is exhausted. High open interest provides fuel for short squeezes, while the net position direction of the market (measured by indicators such as long-short ratio) determines the direction of vulnerability. In a market with massive open interest and a long-short ratio heavily skewed towards longs, a price drop acts like a powder keg waiting to explode, making it highly susceptible to long squeezes.

In markets where open interest exceeds market capitalization, the concept of "liquidity" has reversed. Typically, liquidity can suppress volatility. However, here, the "liquidation liquidity" constituted by the strong market orders waiting to be triggered creates volatility instead.

These liquidation levels act like magnets for prices, as large traders ("whales") may intentionally push prices toward these areas to trigger a chain liquidation and absorb the resulting instantaneous liquidity. This predatory market dynamic causes price behavior to deviate from the normal random walk.

4. Structural bubbles have become a precedent for short squeezes.

4.1 YFI Anomalies: In-Depth Analysis of Yearn.finance's Unprecedented Market Structure

Yearn.finance (YFI) is a DeFi yield aggregator known for its extremely low token supply (approximately 37,000 tokens). During the "DeFi summer" of 2021, its price soared to over $90,000.

During market peaks, the open interest of YFI perpetual contracts reportedly reached several times its circulating market value (for example, at different times, the open interest was about $500 million, while the market value was only $200-300 million). Behind this phenomenon is its extremely low circulation, which makes its spot price susceptible to influence, while its status as a DeFi blue-chip asset has attracted huge derivative speculation trading volume.

This structure has led to extreme volatility and multiple severe long and short squeezes. A backtrace analysis of YFI's "position-to-market cap ratio" clearly shows how it serves as a clear warning of upcoming volatility and the eventual price collapse.

The low supply of YFI has led to a small, vulnerable spot market being overwhelmed by a large speculative derivatives market - specifically, the "open interest to market cap ratio" exceeding 1, which has resulted in extreme volatility.

4.2 Meme Frenzy: The Holdings Dynamics of PEPE and Doge

The value of memes almost entirely comes from the popularity on social media and community sentiment, with essentially no intrinsic utility.

PEPE: In 2023, the price of PEPE experienced an astonishing surge. Meanwhile, its trading volume also reached an all-time high. Reports indicated that its trading volume once exceeded 1 billion USD, which was comparable to its market capitalization, meaning the "trading volume to market cap ratio" was close to or even exceeded 1. The surge in trading volume was clearly linked to the influx of new capital to drive up the price, leading to large-scale short liquidations (reaching 11 million USD within 24 hours).

Doge: During its famous surge in 2021, the holdings of DOGE soared to nearly record levels as prices peaked. In recent market activity, its holdings have once again surpassed the $3 billion mark, with analysts viewing this influx of leveraged bets as a sign of rekindled speculative confidence and potential for significant price volatility.

The above case reveals the complete life cycle of the speculative bubble in the cryptocurrency field.

Phase One: Strong narrative emerges. (Some people believe the narrative is the reason for the rise sought by later generations) Phase Two: Spot prices begin to rise. Stage 3: Speculators flock into the derivatives market, leading to a rapid expansion of open positions, eventually exceeding the market value, which is the most severe stage of the bubble. Phase Four: A catalyst triggers a wave of liquidations, leading to severe short squeezes and cascading liquidations. Phase Five: As leverage is cleared from the system, positions collapse.

By tracking the "position size to market value ratio," traders can identify which stage an asset is in and adjust their strategies accordingly.

V. Conclusion

Participate or Avoid? Risk Assessment Framework

Avoidance (Cautious Approach): For most investors, especially those lacking advanced analytical tools or with lower risk tolerance, a signal of position size exceeding market capitalization is a clear warning to stay away from that market. The volatility at this time is extremely high, and price behavior has decoupled from fundamentals, rendering traditional analytical methods ineffective.

Participation (Professional Path): Only seasoned traders who deeply understand derivative mechanisms, have access to real-time data tools, and adopt strict risk management should consider participating. The objective is not "investment," but to trade the volatility created by structural imbalances in the market; it is a typical PvP market. Analysis must shift to the perspective of game theory: "Where are the majority of market positions? What are their maximum pain points?"

Knowing the facts, one must also understand the reasons behind them.

May we always carry a heart that respects the market.