"Open Interest (OI)" greater than Market Capitalization (MC) is an extremely strong speculative signal. It indicates that an asset's price discovery mechanism has shifted from the spot market to the derivatives market, forming a leverage-driven, fragile, and self-referential system. This environment is decoupled from fundamentals and inherently prone to violent short squeezes and cascading liquidations.
As market liquidity returns, there will be more and more "monster coins" of this type. This article hopes to dissuade those traders who are "confused" and "ready to move" by interpreting this signal.
1. Basic indicators of market activity and value
Before analyzing the extremes emerging in the crypto derivatives market, it’s crucial to establish a precise, technical understanding of the core metrics that measure market activity and asset value. This section provides an in-depth analysis of two key indicators: open interest (OI) and market capitalization (MC).
1.1 Deconstructing Open Interest (OI): A Metric for Market Gaming
The core definition of open interest (OI) is the total number of derivatives contracts (futures) in the market that have not yet been settled, closed out, or exercised at a specific point in time. It is a cumulative indicator that reflects the total number of active positions held by market participants at the end of each trading day.
Open interest is a useful indicator of capital inflows or outflows from the market. An increase in open interest indicates new capital entering the market, which is often seen as confirmation and strengthening of the current trend. Conversely, a decrease in open interest indicates capital outflows (i.e., positions are being closed or liquidated), which suggests that the current trend may be weakening or about to reverse. This characteristic makes open interest an excellent indicator for assessing market sentiment.
We can compare open interest to the market's "potential energy," while trading volume represents "momentum." High open interest represents the accumulation of large leveraged positions (stored potential energy). When this potential energy is released—usually through trend continuation or large-scale liquidation events—high trading volume (the release of momentum) is accompanied.
The amount of accumulated potential energy (OI) determines the scale of the eventual kinetic energy release (dramatic price fluctuations under high trading volume). In simple terms, the higher the OI, the greater the accumulated force, and the more intense the resulting "kinetic light wave."
1.2 Defining Circulating Market Cap: A Snapshot of Spot Market Value
Market capitalization is a core indicator that measures the total value of a cryptocurrency. It is calculated by multiplying the circulating supply of the cryptocurrency by the current market price of a single coin.
It is crucial to understand market capitalization to distinguish between three different concepts of supply:
Circulating Supply (MC): This refers to the number of tokens that are accessible to the public and can be freely traded on the market. This is the indicator of effective market capitalization referred to in this article .
Total Supply: refers to the circulating supply plus the number of tokens that are locked, reserved, or unissued, minus the number of tokens that have been verifiably destroyed.
Max Supply: This refers to the maximum number of tokens that may exist during the life of the cryptocurrency (for example, the maximum supply of Bitcoin is 21 million).
2. Analysis of abnormal phenomena: when holdings OI> market value MC
When the volume of derivatives holdings for an asset exceeds its circulating market value, the market enters an abnormal state. This is a situation where a small horse pulls a large cart, using a 10 million market to control another 100 million market—just like a bubble, brilliant and dazzling, yet sensitive and fragile.
2.1 The Mechanism of Imbalance: How Derivatives Outperform Underlying Assets
The core driver of this imbalance is leverage (there are some "whales" who use 1x leverage with real money, but this is a minority and will not be discussed in this article). In the derivatives market, traders can use a small amount of capital to control notional positions far exceeding their principal. For example, a trader with only $1,000 in margin can control a position worth $100,000 using 100x leverage.
Due to leverage, even if the total margin deposited by all traders is only a small fraction of the asset's market value, the notional value of the open interest can easily exceed the asset's circulating market value. For example, if a token's circulating market value is $100 million, but traders use an average leverage of 20x and open a contract position worth $200 million with only $10 million in margin, their notional open interest will be twice the market value. (In reality, it is not so easy to establish such a position.)
2.2 Interpreting the Signals: Speculative Bubbles, Fragile Structures, and Derivative Dominance
A signal that open interest exceeds market capitalization, or a large accumulation of open interest over a short period of time, is one of the strongest signs that a market is dominated by speculation rather than fundamental investment. It indicates that the "virtual capital" used to bet on the direction of an asset's price has exceeded 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 ratio reveals an extremely fragile market structure that is highly sensitive to volatility. Under this structure, even small changes in spot prices can trigger a disproportionate wave of liquidations in the massive derivatives market, creating a self-reinforcing negative feedback loop. In normal markets, prices reflect fundamentals.
However, in this abnormal state, the internal structure of the market—that is, the distribution and size of leveraged positions—itself became the "fundamentals" driving prices. The market no longer reacted primarily to external news, but rather to its own potential for forced liquidation risks.
At this point, the derivatives market is no longer just a hedging tool for spot positions; it has become the dominant driver of spot prices, creating a "tail wagging the dog" situation. To hedge their risk exposure in the vast derivatives market, arbitrageurs and market makers must buy and sell in the spot market, thereby transmitting derivatives market sentiment directly to spot prices.
2.3 Open Interest to Market Capitalization Ratio: A New Metric for Measuring Systemic Leverage
To quantify this phenomenon, we define the "holding volume to market value ratio" as: total holdings / circulating market value
For example, if the holdings of ABC coin is 10 million and the circulating market capitalization is 100 million, then the ratio is 0.1 (10/100)
The ratio can be interpreted as follows:
Ratio < 0.1: Normal, healthy market. Derivatives may be used primarily for hedging.
Ratio 0.1-0.5: Speculative activity increases. Derivatives become a significant price influencer.
Ratio > 0.5: Highly speculative. Market structure has become fragile.
Ratio > 1.0: Extreme speculation and leverage. The market is in a highly volatile state, prone to short squeezes and cascading liquidations. This is exactly the abnormal signal discussed in this article.
Tracking this ratio is crucial for any asset. A rapid increase in the ratio is a clear warning sign that leverage is accumulating and volatility is imminent. This anomaly indicates that the asset's trading price has completely decoupled from its fundamental value, becoming a function of leverage.
This is particularly common for assets with low circulating supply and a strong narrative, popularized by influencers (KOLs), and extensive media coverage, such as many new coins in this era. Initially low circulating supply makes the spot market more susceptible to manipulation, while the strong narrative attracts significant speculative interest into the derivatives market, creating the perfect storm for this ratio to exceed 1.
3. The Bubble Will Burst: Volatility, Short Squeezes, and Chain Liquidations
When OI > MC, it is like a sealed room filled with gas, and only a tiny spark is needed to create an unknown firework - and the name of this room is "short squeeze".
3.1 Adding fuel to the fire: How extreme open interest creates conditions for a short squeeze
High open interest means a large number of leveraged long/short positions are densely distributed around certain prices. Each of these positions carries a liquidation price. The sum of these positions creates a large pool of potential forced market orders (buy or sell) that can be triggered in a chain reaction if the price moves in an unfavorable direction.
The basic principle: Long positions profit from rising prices, while short positions profit from falling prices. To close a long position, you sell; to close a short position, you buy. This is fundamental to understanding the mechanics of a short squeeze.
3.2 Analysis of the Long Squeeze
A long short squeeze is a sudden, sharp price drop that forces traders holding leveraged long positions to sell their positions to limit losses.
The mechanism is as follows:
Initial decline: A catalyst (such as negative news or a large spot sell-off) triggers an initial price drop.
Liquidation Trigger: Price hits the liquidation level for the first batch of highly leveraged long positions.
Forced sell: The exchange’s liquidation engine automatically forces a sell of the collateral for these positions in the market, putting further downward pressure on prices.
Chain effect: A new round of selling 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 Analysis of a Short Squeeze
A short squeeze is a sudden, sharp price increase that forces short traders to buy back an asset to cover their positions.
The mechanism is as follows:
Initial Rise: A catalyst (such as positive news or coordinated buying) triggers an initial rise in prices.
Covering pressure: Short traders begin to incur losses. Some will actively buy back assets ("short covering") to limit losses.
Liquidation Trigger: Price hits the liquidation level for a high leverage short position.
Forced buying: The exchange’s liquidation engine forces buying of assets in the market to cover these short positions, generating massive upward pressure. This forced buying pushes prices higher, thereby “squeezing out” more shorts and creating a powerful, self-reinforcing upward cycle.
3.4 Domino Effect: The Vicious Cycle of Chain Liquidation
Cascading liquidations are the primary mechanism by which volatility is amplified in highly leveraged markets. They are responsible for the "needle in the sky" phenomenon commonly seen on cryptocurrency charts—a rapid, sharp price movement in one direction followed by a rapid reversal once liquidations are exhausted. High open interest fuels short squeezes, while the direction of the market's net position (measured by indicators such as the long-short ratio) determines the direction of vulnerability. A market with high open interest and a heavily bullish long-short ratio becomes a powder keg waiting to explode when prices fall, making it highly susceptible to a bull short squeeze.
In a market where open interest exceeds market capitalization, the concept of "liquidity" is reversed. Normally, liquidity dampens volatility. However, here, "liquidation liquidity," consisting of forced market orders waiting to be triggered, actually creates volatility.
These liquidation levels act like magnets for price, as large traders (“whales”) may intentionally push prices toward these areas to trigger cascading liquidations and absorb the resulting instant liquidity. This predatory market dynamic causes price behavior to deviate from the norm of a random walk.
4. Structural bubbles become a precedent for short squeezes
4.1 YFI Anomaly: In-depth Analysis
Yearn.finance’s unprecedented market structure
YFI (YFI), a DeFi yield aggregator known for its extremely low token supply (approximately 37,000), saw its price surge to over $90,000 during the “Summer of DeFi” of 2021.
At market peaks, open interest in YFI perpetual contracts reportedly reached several times its circulating market capitalization (e.g., at various times, open interest was approximately $500 million, while the market capitalization was only $200-300 million). This phenomenon is attributed to its extremely low circulating supply, which makes its spot price susceptible to price fluctuations, and its status as a blue-chip DeFi asset, which has attracted significant speculative derivatives trading volume.
This structure has led to extreme volatility and multiple violent long and short squeezes. A retrospective analysis of YFI’s open interest to market capitalization ratio clearly shows how it has become a clear warning of impending volatility and an eventual price crash.
YFI’s low supply has resulted in a small, vulnerable spot market being overwhelmed by a large, speculative derivatives market—that is, the “open interest to market capitalization ratio” exceeds 1, and wild volatility has ensued.
4.2 Memes Mania: PEPE and Doge Holdings Dynamics
The value of memes comes almost entirely from social media popularity and community sentiment, and they have little intrinsic utility.
PEPE: In 2023, PEPE prices experienced a staggering surge. Simultaneously, its open interest reached a record high. Reports indicate that open interest briefly exceeded $1 billion, comparable to its market capitalization, implying a "open interest to market capitalization ratio" approaching or even exceeding 1. This surge in open interest has been clearly linked to the influx of new funds fueling the rally, leading to massive short liquidations (reaching $11 million within 24 hours).
Doge: During its famous 2021 rally, DOGE's open interest surged to near-record levels as prices peaked. Recent market activity has seen its open interest surpass the $3 billion mark again, with analysts viewing this influx of leveraged bets as a sign of renewed speculative confidence and potential for significant price volatility.
The above cases reveal the complete life cycle of speculative bubbles in the crypto field.
Phase 1: A strong narrative emerges. (Some believe that narrative is the reason for the rise that future generations seek.)
Phase 2: Spot prices begin to rise.
Phase 3: Speculators flock to the derivatives market, causing holdings to expand rapidly and eventually exceed the market value. This is the most serious stage of the bubble.
Phase 4: A catalyst triggers a wave of liquidations, leading to a violent short squeeze and chain liquidations.
Phase 5: Open interest collapses as leverage is removed from the system.
By tracking the open interest to market capitalization ratio, traders can identify which phase an asset is in and adjust their strategies accordingly.
V. Conclusion
Engage or Avoid? A Risk Assessment Framework
Avoidance (Careful Approach): For most investors, especially those lacking advanced analytical tools or with a low risk tolerance, a signal indicating that holdings exceed market capitalization is a clear warning to stay away from the market. Volatility is extremely high at this time, and price action is disconnected from fundamentals, rendering traditional analytical methods ineffective.
Participation (Professional Approach): Only experienced traders with a deep understanding of derivatives mechanics, access to real-time data tools, and rigorous risk management should consider participating. The goal isn't "investing," but rather trading the volatility created by structural market imbalances. This is a classic player-versus-player market. Analysis must shift to a game-theoretic perspective: "Where are the majority of the market's positions? Where are their biggest pain points?"
Knowing that it is so, he also knows why it is so.
May we always maintain a heart of awe for the market.
Note: Due to space constraints, this article will not discuss how to participate/use the platform. Interested parties can discuss it in the comments section. If you're interested, we'll open a separate post to discuss it.
Appendix: Risk Management Checklist
