Coinbase predicts a longer crypto winter – cross-chain liquidity could save the day

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2022 was a bit of a nightmare for the crypto industry. Its market capitalization shrank by nearly 60% over the year, from $2.2 trillion to $797 billion.

The two leading coins by market capitalization – Bitcoin (BTC) and Ether (ETH) – also decreased by 64% and 67% respectively.

Terra (LUNA) crashed in May. Then the Fed raised interest rates in the US. These factors, among others, significantly rattled the crypto market, putting it on pause.

And finally, in November, FTX – the third largest crypto exchange at the time – exploded after serious allegations of misappropriation of users’ funds.

FTX’s collapse will have “second-order effects” that could extend the ongoing crypto winter until the end of 2023, according to a report from Coinbase. Since many institutional investors have their funds tied up in FTX, “poor liquidity conditions” may prevail for some time now.

These claims have considerable merit – but from a single chain perspective on liquidity. Although more macroeconomic changes are necessary for crypto markets to fully recover, draining liquidity across chains is a crucial means to this end.

In addition to offsetting the liquidity crunch caused by the FTX fiasco, it could improve price stability and volume. And with greater ease of access, the aggregation of liquidity across chains can attract private and institutional investors.

Crypto’s liquidity crisis is bigger than FTX’s

The collapse of massive players, such as FTX, Terra and others, is undoubtedly a major reason behind the crypto industry’s liquidity crisis.

But to be fair, the problem is bigger and more fundamental than how particular companies go about their business or fail to do so.

To work in the right direction with realistic expectations, stakeholders need to call a spade a spade instead of playing the simple blame game.

Therefore, without discounting the role of FTX or Terra, it is important to consider the fragmented architecture that makes crypto projects vulnerable to liquidity crises.

Liquidity remains locked in silos across blockchains, staking pools and applications that don’t – or can’t – pphare resources when necessary. This causes a huge underutilization of the total value invested in crypto-based protocols.

But on a more practical day-to-day level, fragmented liquidity means inefficient price discovery and even slippage for larger trades – an obstacle to institutional participation.

Fragmented liquidity becomes an even greater problem during market downturns when capital inflows are low. This is when routing liquidity across protocols comes in handy – but it is usually challenging, if not impossible.

Protocols thus enter a vicious circle of lower liquidity and greater slippage, ultimately losing investors.

So much for the technical problems that innovation solves. But it is noteworthy that the ongoing liquidity crisis is also due to macroeconomic factors beyond the industry’s control.

The Fed’s rate hike is a key aspect here, with terminal rates expected to reach 5.4% by June 2023. Moreover, a US recession is also likely. And to make matters worse, there is too much uncertainty regarding crypto regulations worldwide, including in the US, UK and EU.

Make crypto borderless – and limitless

On the outside, crypto has no boundaries. It is one of the most important advantages over traditional asset classes and currencies.

In the same way, therefore, crypto-assets must flow freely across chains and protocols. This will unlock the full value and potential of these assets, introducing unforeseen opportunities.

There is another somewhat moralistic rationale for why the crypto liquidity landscape must not be siloed. It relates to how value is segregated in exclusive, non-collaborative systems in the internet’s traditional framework.

Giants exercise full control over isolated resources, maximizing profits via exclusivity while limiting consumer scope.

Crypto as a whole is meant to disrupt unfair business models and practices that undermine the interests of consumers and end users. Promoting competitive cooperation is crucial in this regard.

It is a journey from economic exclusion to inclusion and must reflect on all levels – from protocol to local communities. Therefore, platforms must use smart liquidity routing to ensure a seamless experience for retail and institutional users.

Given the current crisis, using smart cross-chain aggregators can help improve transactions and trades by directing liquidity from multiple sources. This is particularly useful for cross-chain token exchanges, where it is otherwise challenging to measure price stability and available volume.

Also, blockchain-agnostic aggregation solutions work with all kinds of platforms – DEXs, DeFi protocols, NFT marketplaces, wallets, arbitrage bots and money markets.

Tools like these provide the technical foundation for genuinely borderless crypto. Now it is up to industry stakeholders to leverage them to overcome adverse market conditions.

Act now, act fast, act wisely

Not in the alarmist sense – but quick and wise action is essential in this hour. Because instead of waiting for macroeconomic conditions to improve, or while they do, you need to take advantage of what is already available.

Now is the time to make liquidity sharing across chains the norm.

Doing so will rest the industry on a more stable foundation, allowing for more efficient price discovery and less uncertainty about volume. Institutional players who conduct larger trades will greatly benefit from this scenario.

This will provide the much needed incentives to increase their participation in crypto. And naturally, the subsequent “rising tide” effect will also create positive results for retail investors.

Building products during a bear market to solve the industry’s problems from within obviously seems easier said than done. However, innovators can offset this difficulty by using intuitive widgets, APIs, and SDKs.

Such trouble-free solutions provide a cost-effective and quick way to enter the market – perfect for the current scenario.

Also from the perspective of retail users, user-friendly liquidity aggregators make crypto-based financial services more accessible and relevant on a daily basis.

Consumers are more aware of where they put their money during downturns. FOMO and hype don’t push them toward rash decisions. So they are more likely to adopt products that are actually valuable to them and have a wide range.

Therefore, to conclude, aggregating liquidity across chains can strengthen crypto in at least two ways. One, by providing a more stable base. Two, by increasing retail and institutional adoption.

And while Coinbase is right to point out the possible consequences of the FTX collapse, it is not fully considering the tools available to overcome the crypto winter sooner rather than later.

Viveik Vivekananthan is the founder and CEO of Swing, a decentralized cross-chain liquidity protocol. Viveik has a background in computer science and experience from the technology industry, including positions at Blackberry and Apple.

Featured image: Shutterstock/Dr.Roza