Author: A1 Research
Translation: Tim, PANews
The price fluctuations of Ether (ETH) seem simple: retail enthusiasm surges, prices soar, and market optimism continues to ferment. But beneath the surface lies a structurally complex market mechanism. The intertwining of capital rate markets, hedging operations by neutral strategy institutions, and recursive leverage demand exposes deep systemic vulnerabilities in the current crypto market.
We are witnessing a rare phenomenon: leverage has essentially transformed into liquidity itself. The massive long positions taken by retail investors are fundamentally reshaping the way neutral capital allocation risks are approached, thus giving rise to a new type of market vulnerability that most market participants have yet to fully recognize.
1. Retail FOMO in Long Positions: When market behavior is highly synchronized
Retail demand concentrates on Ether perpetual contracts because these leveraged products are easy to access. Traders flood into leveraged long positions at a rate far exceeding the actual demand for spot purchases. The number of people betting on ETH's rise far exceeds those actually buying Ether spot.
These positions require counterparties to take them on. However, as buying demand becomes unusually aggressive, short positions are increasingly absorbed by institutional players executing delta-neutral strategies. These are not directional bears but funding rate harvesters who intervene not to short ETH but to exploit structural imbalances for arbitrage.
In fact, this practice does not constitute traditional shorting. These traders short perpetual contracts while holding equivalent amounts of spot or futures long positions. As a result, while they do not bear ETH price risk, they profit from the funding rate premiums paid by retail longs to maintain leveraged positions.
With the evolution of the Ether ETF structure, this kind of arbitrage trading may soon be enhanced through the layering of passive income (staking returns embedded in the ETF packaging structure), further strengthening the appeal of delta-neutral strategies.
This is indeed a brilliant trade, provided you can endure its complexity.
Delta Neutral Hedging Strategy: A legitimate "money printing" response mechanism
Traders short ETH perpetual contracts to accommodate retail long demand while hedging with spot long positions, thus transforming the structural imbalance caused by continuous funding rate demand into profit.
In a bullish market, the funding rate turns positive, at which point longs must pay shorts. Institutions using neutral strategies can earn profits while hedging risks by providing liquidity, forming profitable arbitrage operations that attract continuous inflows of institutional capital.
However, this gives rise to a dangerous illusion: the market appears deep enough and stable, but this ‘liquidity’ depends on a favorable capital environment.
The moment the incentive mechanism disappears, the structure it supports will also collapse. The apparent market depth instantly turns to void, and with the thunderous collapse of the market framework, prices may experience severe volatility.
This dynamic is not limited to crypto-native platforms. Even at the institutionally dominated Chicago Mercantile Exchange, much of the short liquidity is not directional bets. Professional traders short CME futures because their investment strategies prohibit opening spot exposure.
Options market makers hedge delta through futures to enhance margin efficiency. Institutions are responsible for hedging institutional client order flows. These are structural necessary trades, not reflections of bearish expectations. Open interest may rise, but this rarely conveys market consensus.
Asymmetric risk structure: Why it's actually unfair
Retail longs face direct liquidation risks when prices move unfavorably, whereas delta-neutral shorts typically have more substantial capital and are managed by professional teams.
They collateralize their held ETH as collateral and can short perpetual contracts under a fully hedged and capital-efficient mechanism. This structure can safely withstand moderate leverage without triggering liquidation.
There are structural differences between the two. Institutional shorts have enduring resilience and a robust risk management system to withstand volatility; whereas leveraged retail longs have weak capacity and a lack of risk control tools, with their operational margin for error nearly zero.
When market conditions shift, longs quickly unravel, while shorts remain solid. This imbalance can trigger what seems like a sudden, structurally inevitable liquidation waterfall.
Recursive Feedback Loop: When market behavior becomes self-interfering
The sustained demand for long positions in Ether perpetual contracts requires delta-neutral strategy traders to act as counterparties for short hedging, a mechanism that allows funding rate premiums to persist. Various protocols and yield products compete to chase these premiums, driving more capital back into this cyclical system.
A never-ending money-making machine does not exist in reality.
This will continually create upward pressure, but it entirely depends on one prerequisite: longs must be willing to bear the cost of leverage.
The funding rate mechanism has an upper limit. At most exchanges (like Binance), the funding rate cap for perpetual contracts is 0.01% every 8 hours, equivalent to an annualized yield of about 10.5%. When this cap is reached, even if long demand continues to grow, shorts seeking yield will no longer be incentivized to open positions.
Risk accumulation reaches a critical point: arbitrage profits are fixed, but structural risks continue to grow. When this critical point arrives, the market is likely to rapidly liquidate.
Why does ETH drop harder than BTC? The rivalry of twin narratives
Bitcoin benefits from non-leveraged buying brought by corporate financial strategies, while the BTC derivatives market has stronger liquidity. Ether perpetual contracts are deeply integrated into yield strategies and the DeFi protocol ecosystem, with ETH collateral continuously flowing into structured products like Ethena and Pendle, providing yield returns for users participating in funding rate arbitrage.
Bitcoin is generally considered to be driven by the natural spot demand from ETFs and corporations. However, a significant portion of ETF capital flows are actually the result of mechanical hedging: traditional financial basis traders buy ETF shares while shorting CME futures contracts to lock in the fixed spread between spot and futures for arbitrage.
This is essentially the same as the nature of ETH's delta-neutral basis trading, only executed through a regulated packaged structure and financed at a dollar cost of 4-5%. In this light, ETH's leveraged operations become yield infrastructure, while BTC's leverage forms structured arbitrage. Neither are directional trades, both aim for benefit acquisition.
Cyclic Dependency Issue: When the music stops
Here’s a question that may keep you awake at night: this dynamic mechanism has an inherent cyclical quality. The profitability of delta-neutral strategies relies on a continuously positive funding rate, which requires sustained retail demand and a long-term bullish environment.
The funding rate premium is not permanently existent; it is very fragile. When the premium contracts, a wave of liquidations begins. If retail enthusiasm wanes and the funding rate turns negative, it indicates that shorts will pay longs instead of collecting a premium.
When large-scale capital flows in, this dynamic mechanism forms multiple vulnerabilities. First, as more capital flows into delta-neutral strategies, the basis will continue to compress. The financing rate declines, and arbitrage trading profits also decrease.
If demand reverses or liquidity dries up, perpetual contracts may enter a discount state, where contract prices fall below spot prices. This phenomenon hinders the entry of new delta-neutral positions and may force existing institutions to liquidate. Meanwhile, leveraged longs lack margin buffer space, and even a mild market pullback could trigger a chain liquidation.
When neutral traders withdraw liquidity and longs are forced to liquidate like a waterfall, a liquidity vacuum forms, leaving no real directional buyers below the price, only structural sellers. The originally stable arbitrage ecosystem rapidly reverses, evolving into a chaotic liquidation wave.
Misreading market signals: the illusion of balance
Market participants often misinterpret the flow of hedging funds as bearish tendencies. In reality, high short positions in ETH often reflect profitable basis trading rather than directional expectations.
In many cases, the seemingly strong depth of derivative markets is actually supported by temporary liquidity provided by neutral trading desks, which earn profits by harvesting funding premiums.
While the capital inflow into spot ETFs can generate a certain degree of natural demand, the vast majority of transactions in the perpetual contract market are fundamentally structural artificial operations.
Ether's liquidity is not rooted in faith in its future; it will exist as long as the capital environment is profitable. Once profits dissipate, liquidity will also flow away.
Conclusion
The market can remain active for a long time under structural liquidity support, creating a false sense of security. But when conditions reverse and longs cannot maintain financing obligations, the collapse happens in an instant. One side is utterly crushed while the other calmly withdraws.
For market participants, identifying these patterns signals both opportunity and risk. Institutions can profit by understanding funding conditions, while retail investors should differentiate between artificial depth and genuine depth.
The driving factors behind the Ether derivatives market are not consensus on decentralized computing but rather the behavior of structurally harvesting funding rate premiums. As long as the funding rate maintains positive yields, the entire system can operate smoothly. However, when situations reverse, people will ultimately discover that the seemingly balanced facade is merely a carefully disguised leverage game.
(The above content is excerpted and reprinted with the permission of the partner PANews, original link)
"Is the rise to $3600 driven by genuine demand? Unveiling the arbitrage game behind ETH spot and perpetual contracts" was first published on (Blockke).
