The collapse of the banking network also poses a significant risk to the health of the crypto market and coins like Bitcoin.
While the price of Bitcoin has recovered since its lows in March, reaching a high of 28,900 USD, the crisis that caused the initial slump still poses a problem for the market.
The closure of Silvergate’s SEN network and Signature’s Signet network in early March has exposed the crypto market to the risk of low liquidity.
“Liquidity is king” – a saying in trading circles – aptly describes the importance of liquidity. It characterizes a market’s ability to facilitate exchanges between an asset and fiat currency.
Low 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 significant volatility and discourage experienced investors from transacting.
Kaiko’s head of research, Clara Medalie, emphasizes that the current situation is “quite dangerous” and could lead to massive price fluctuations in both directions. Medal:
“A drop in liquidity certainly helps traders upside, but there is always a downside at the end of the day. The moment buying pressure subsides, anything can happen to the price.”
The liquidity crisis in Bitcoin
The liquidity crisis initially manifested itself with a 1% drop in market depth of 200 million USD following the shutdown of Silvergate’s SEN network, Kaiko’s latest research note notes.
The 1% market depth is calculated by summing the bids and requests within 1% of the median price for the top ten cryptocurrencies. When market depth is sufficient and order books are crowded around the market price, it reduces the volatility of the market.
Market depth for Bitcoin (is the bull run delayed?) and Ethereum are still 16.12% and 17.64% below their monthly opening levels, respectively. Kaiko analyst Conor Ryder writes:
“We currently have the lowest level of liquidity in BTC markets in 10 months, even lower than post-FTX.”
BTC and ETH 1% market depth in March 2023. Source: Kaiko.
The liquidity shortage also causes inefficiencies such as high slippage and wider spreads. Coinbase’s BTC-USD pair is currently experiencing slippage almost three times higher than it was in early March.
Slippage refers to the price at which an order is placed and the final price when that 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 suffered a setback after the exchange ended its zero-fee program.
As a result, the pair’s liquidity has decreased by 70% as market makers move on to greener pastures.
These conditions have discouraged market makers and experienced day traders from placing trades as the additional costs incurred by the market’s inefficiency further exacerbate the low liquidity environment.
The Need for Fiat-On-Ramps
The market share of fiat dollars and stablecoins has also shifted dramatically, with stablecoin volume on centralized exchanges increasing from a 77% share to 95% in just over a year.
This trend has rapidly accelerated following the closure of crypto banking networks.
Stablecoin market share (blue) in March 2023. Source: Kaiko.
While switching to stablecoin trading pairs is not a problem for medium and small investors, it can become a problem for more sophisticated traders.
Medalie explains that USD networks are essential for traders who need to conduct their trades on a daily basis:
“Stablecoins are not ideal from a risk management perspective, especially if they are intended to be settled at the end of the day or week.”
“If banks close and stop processing transactions, then stablecoins are the next best alternative.”