Liquidity crunch
As BTCs price has regained momentum since its March lows, pushing close to the $28,900 mark, the resulting crisis still has many in the market worried. It has been revealed that Silvergate’s SEN and Signature’s Signet networks were shut down in early March, thus raising fears about the cryptocurrency market’s liquidity. Low liquidity can create inefficiencies for traders and often lead to thin order books, greater spreads, and huge volatility, factors that could dissuade even the most experienced investors from partaking in transactions.
Crypto markets boast high liquidity, and arguably the most relevant measure of this is market depth. It reveals how many orders are waiting to be filled within a given price range. By summing bids and asks within 1% of the mid-price of the top 10 crypto assets, we get a great indication of the liquidity present in markets. According to the data by Kaiko the overall liquidity of the markets received a shock after the failure of the three major US banks, two of which were tied to crypto-related businesses.
Analyzing the market trend for BTC over the last few months paints a rather cautionary picture. Currently, the liquidity levels in BTC markets had plunged to their lowest level in the last 10 months, dipping even lower than when FTX/Alameda ceased its operations. Unfortunately, that gap has yet to be filled, and the recent banking issues have further exacerbated the liquidity problem, per Kaiko.
BTC market depth. Source: Kaiko
Importance of stablecoins
In the span of a year, the market share of fiat dollars and stablecoins saw a drastic transformation. Stablecoin volumes on centralized exchanges rocketed from a 77% share to 95%. This shift was hastened by the closure of crypto banking networks, creating difficulties for more sophisticated traders who need USD networks to settle their trades daily.
Stablecoin market share on centralized exchanges. Source: Kaiko
With the increase in stablecoin holdings, we could argue that traders are looking to keep more “dry powder” in case of major swings in the markets. Ironically enough, the mere fact that traders are staying on the sidelines could cause greater volatility in the traditionally volatile crypto markets.
Experts chime in
While the liquidity is seemingly drying up, experts in the crypto sphere jumped on the chance to share their vision of how the liquidity aspect could be improved. Thus, Lucas Kiely, Chief Investment Officer of Yield App, drove home the point that having dependable and reliable off-ramps is vital in order to maintain market stability amid liquidity concerns. Sigal Biran Nager of GK8 underscored the necessity of both on- and off-ramps to facilitate liquidity, as well as the importance of more coherent regulations.
Aaron Rafferty from Standard DAO pointed out that the disruption of liquidity can reduce crypto asset values. He also highlighted the potential of decentralized finance (DeFi) solutions and self-custody solutions in preserving assets in case of a banking collapse.
All in all, experts suggest that the liquidity crisis can be overcome by finding substitute sources of liquidity, improving market effectiveness with the help of stablecoins, and furthering the adoption of appropriate regulations and DeFi solutions.
Meanwhile, the raging battle for the control and distribution of cryptocurrencies in the US has been an ongoing one. In late March 2023, Binance faced regulators over potential security violations, only days after Coinbase, their main competitor, had received similar warnings.
Nevertheless, this has not hampered the positive outlook for digital currencies; early 2023 already looks like a turning point for BTC, Ethereum (ETH), and other digital assets. According to Matthew Sigel, head of digital asset research at ETFs, 2024 will be the year where “crypto fruits are harvested.”
Crypto as an alternative
The crypto market of 2022 was undoubtedly tumultuous; however, the subsequent March bank panic provided a spark of hope for both BTC and ETH. These two cryptocurrencies proved to be the most resilient, steadfastly weathering the ebbs and flows of the market and coming out on top despite US banking woes.
After BTC surged to an impressive $28,000 and ETH stabilized at a higher rate than prior, financial professionals have expressed a surge in confidence toward cryptocurrencies, primarily BTC and ETH, which can be seen even in the international market.
Investors were elated by crypto’s resilience during the banking crisis, particularly given BTCs lowest correlation to stocks in months. This is helping to create a new narrative for BTC as a precious alternative asset. Nevertheless, BTCs price is still highly impacted by inflation and Federal Reserve rate increases.
Where do we go from here?
It’s a fact: investors are increasingly switching from USD pairs to stablecoins. This means institutional issues rather than investor issues are preventing the lack of USD payment rails.
But, everyone in the crypto space has still been affected by reduced liquidity, slippage, and wider spreads. We are sure someone in the US will soon be able to provide a SEN/Signet-like payment network, as the demand is huge. Once this happens, liquidity will increase, leading to less volatility and making crypto a more attractive asset class to new investors, thus initiating the next bull market.
Until this actually plays out, we will probably see more cautious trading by investors and higher volatility in crypto markets. There are, of course, positive signals coming from the broader markets, such as decreasing inflation and a possible reduction in further Federal Reserve interventions. All of this could spur crypto on, but the threat of indiscriminate regulation still looms large over crypto in the US.
Conclusion
For small investors that hold a few thousand in BTC, the best thing to do at the moment is probably to do nothing. The liquidity crisis will play itself out, with new payment rails coming online, perhaps in the US, perhaps off-shore to allow trade settlements. Just like the US banks, crypto, and crypto trading have become almost too big to fail, which means that a solution is right around the corner.
For those looking to invest, perhaps a “wait and see,” approach could work best, as more volatility is expected in the short term. This could translate into great buying opportunities. And finally, for the traders, there is not much to suggest, besides reading our post on the top 10 cryptocurrencies to keep an eye on in 2023.
