Bitcoin’s Liquidity Declining Despite Strong Performance in Cryptocurrency Market

The recent banking crisis has turned out to be a blessing in disguise for Bitcoin as it has become a surprise winner in the market with its price surging 40% to around $27,700 since March 10. However, investors aiming to increase their bets on the cryptocurrency are facing an ominous obstacle – a lack of liquidity that could result in wild price swings. Bitcoin’s market depth indicates that it is currently at its lowest level of liquidity in ten months, lower than it was in the aftermath of the FTX collapse in November, according to data provider Kaiko. The market depth for the two leading trading pairs – bitcoin-dollar and bitcoin-tether – stands at 5,600 bitcoin, the equivalent of about $155 million.

As a result, slippage has also increased, which is a liquidity measure describing how much prices change between the placement and execution of a trade. Slippage for buying bitcoin with U.S. dollars on the Coinbase exchange is 2.5 times higher than it was at the start of March. Additionally, the slippage for a simulated $100,000 sell order has doubled in the past month, meaning that the average price for each bitcoin is worse than it was a month ago. The network effect has been adversely affected by the collapses of Silvergate Capital and Signature Bank, whose networks had long been used by market makers to transact with exchanges.

Lower liquidity generally means more volatile markets, particularly in crypto, and this could be one factor behind bitcoin’s surge this month. The increase in Bitcoin’s volatility has also been reflected in CryptoCompare’s Bitcoin Volatility Index, which spiked to 96 last week, significantly higher than the range of 52 to 65 it saw last month. However, this index is currently hovering around 68.

Further crimping liquidity is Binance, the world’s most liquid crypto exchange, which ended zero-fee trading for almost all its bitcoin trading pairs last week, impacting market makers’ ability to charge higher fees for executing trades on the platform. Liquidity for the bitcoin-tether pair on Binance has dropped 70% since the announcement, while trading volumes have fallen 90%, according to Kaiko data.

The vanishing liquidity can be traced back to the collapse of Sam Bankman-Fried’s FTX exchange and hedge fund Alameda Research. Alameda was one of the biggest liquidity providers in the crypto industry, and its bankruptcy left a void that has been exacerbated by the banking sector turmoil of 2023. While most market participants expect new contenders to gradually emerge to perform the network functions of Silvergate and Signature, they say complete replacements are unlikely to pop up overnight. Until then, “liquidity is probably going to get worse and worse,” said Joseph Edwards, an investment adviser at Enigma Securities.

Moreover, it’s not just market-maker trouble that’s crunching crypto liquidity. Despite bitcoin’s recent rally following a lengthy downturn, many investors are still trading cautiously in the wake of the banking crises and rising interest rates, according to some specialists. “Even if some players haven’t left the place, they are on the sidelines right now because of what’s happening with banking turmoil,” said Edwards.

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