Bitcoin liquidity hits 10-month low amid US banking crisis

While Bitcoin’s price has recovered from March lows, reaching nearly $28,900, the crisis that caused the initial decline remains a concern for the market.

The shutdown of Silvergate’s SEN and Signature’s Signet networks in early March has exposed the crypto market to low liquidity risk.

“Liquidity is king,” a saying in trading circles, is an apt way to describe its importance. It describes a market’s ability to facilitate conversion between an asset and fiat currency.

Poor liquidity around an asset leads to market inefficiencies where traders lose money due to events such as thin order books, slippage and wider spreads. It can also cause severe volatility and deter sophisticated investors from placing trades.

Kaiko’s head of research, Clara Medalie, said so Decrypt that the current situation is “quite dangerous” and can manifest itself in massive price volatility in both directions.

“A drop in liquidity certainly helps traders to the upside, but there’s always a downside in the end,” Medalie said. “The moment the buying pressure subsides, anything can happen to the price.”

Crypto’s Liquidity Crisis

The liquidity crisis first manifested itself with a $200m drop in 1% market depth after Silvergate’s SEN network was shut down, as identified in Kaiko’s latest research note.

The 1% market depth is calculated by summing the bids and asks within 1% of the mid-price of the top 10 cryptocurrencies. If the market depth is sufficient and the order books are crowded around the market price, it reduces the volatility of the market.

Market depth for Bitcoin and Ethereum remains down 16.12% and 17.64% respectively from their monthly opening levels. Kaiko analyst Conor Ryder wrote that “we are currently at our lowest level of liquidity in the BTC markets in 10 months, even lower than the aftermath of FTX.”

BTC and ETH 1% market depth in March 2023. Source: Kaiko.

The liquidity crisis also causes inefficiencies such as high slippage and wider spreads. Coinbase’s BTC-USD pair is currently showing almost three times higher slippage than at the beginning of March.

Slippage refers to the price at which an order is placed and the final price when the order is actually executed. In low liquidity environments, the difference between these two orders can be much larger than usual.

The most liquid pair in the crypto market, the BTC-USDT pair on Binance, also took a hit after the exchange ended its zero-free program.

As a result, the pair’s liquidity depleted by 70% as market makers moved to greener pastures.

These conditions have discouraged market makers and sophisticated day traders from placing trades due to the additional costs incurred due to market inefficiencies, and exacerbated the low liquidity environment.

The need for fiat-on-ramps

The market share of fiat dollars and stablecoins has also changed drastically, with stablecoin volumes on centralized exchanges rising from a 77% share of volumes to 95% in just over a year.

The trend accelerated rapidly after the closure of crypto banking networks.

Stablecoin market share (blue) in March 2023. Source: Kaiko.

Although switching to stablecoin trading pairs does not pose a problem for medium to small-scale investors, it can become a problem for more sophisticated traders.

Medalie explained that the USD network is essential for traders, who are required to settle their trades daily.

“Stablecoins are not ideal from a risk management perspective, especially for settling at the end of the day or week,” she said. “But if the banks are closing and not processing transactions, then stablecoins are the next best option.”