FTX and Binance Debacles Crater Crypto Liquidity
Big Problems for Traders of non-BTC Assets
The crypto markets are reeling from a profound lack of liquidity that began with the November 2022 collapse of FTX and more recently was worsened by the $4.3 billion legal settlement against Binance. This means that traders will have a tough time taking sizeable new long positions, or selling out of existing ones, without moving the market against them. But bitcoin could sidestep this problem, which would widen the gulf between it and smaller fry cryptos.
Even bitcoin, with its $740 billion market cap, is not immune to the liquidity issue. However, many BTC boosters think the prospect of large institutional investments through the bitcoin ETF currently being vetted by the U.S. Securities and Exchange Commission, combined with a large technical bid that comes around every four years, could maintain appropriate liquidity in the market-leading crypto.
Binance has not seen any outsized FTX-style runs. According to DefiLlama, its total assets on November 30 totaled some $66.9 billion, about where its total was at the end of 2022. But it has lost nearly half of its market share for spot crypto over that time, ending up with about a 32% share, according to the Financial Times.
Nonetheless, the exchange’s trading book liquidity is down a lot, and that’s bad news for crypto traders. (An exchange might have a stable amount of assets, but changing degrees of participation by market makers and other investors can change the depth of its liquidity, meaning it is harder to buy and sell assets without moving the market.)
Kaiko research analyst Conor Ryder recently took to task market participants who blithely use market cap as a proxy for liquidity. “I’ve said the same thing for the last three liquidity ranking updates: simply assuming a token is as liquid as its market cap suggests is lazy and negligent... there are some huge outliers that can mislead investors who use market cap as a proxy for liquidity. These outliers highlight the need for investors to incorporate liquidity management as part of their investment process, particularly in the low liquidity environment in which we find ourselves now.”
A CoinDesk analysis of Kaiko’s data showed that on November 22, “Liquidity for top cryptocurrencies on [Binance], measured by 0.1% and 1% market depth indicators, [had] declined by 25% or more to less than $150 million and around $180 million, respectively.... Market depth is a collection of buy and sell orders within a certain percent of the mid-price, or the average of the bid and the ask prices.” The author, Omkar Godbole, explained that moving the market by 0.1% and 1% in either direction was then 25% easier than it had been 24 hours earlier.
“It also means trading large orders on Binance at stable prices has become tougher, exposing so-called whales to slippage, that is movement between the price quoted when a trader places the order and what they actually pay when the order is filled,” Godbole wrote.
The Corporate Finance Institute outlines the three big benefits of crypto liquidity in a useful primer on its website. (Just reverse them to understand the dangers.) These show how important it is to understand the concept of liquidity, and how this understanding should inform investment decisions.
1. Liquidity in cryptocurrency makes it hard to manipulate prices. Liquidity in cryptocurrency makes it less susceptible to manipulations of the market by dishonest actors or groups of actors.
2. Liquidity in cryptocurrency offers stability in prices and less volatility. A liquid market is considered more steady and less volatile as a thriving market with considerable trading activity can bring buy and sell market forces into harmony. As a result, anytime you sell or purchase, there will always be market participants prepared to do the opposite. People can initiate and exit positions in highly liquid markets with little slippage or price fluctuation.
3. Liquidity in cryptocurrency helps in analyzing behaviors of traders. A larger number of both sell and buy orders reduces volatility and gives traders a comprehensive picture of market forces and can help produce more accurate and reliable technical data. Traders will be able to better analyze the market, make accurate predictions, and make well-informed decisions as a result.
Will bitcoin stand alone?
Hopes for regulatory approval of a bitcoin ETF are running high and contributed to inflows to bitcoin products hitting $1.5 billion in late November, the most since its rally in 2021, according to Bloomberg. The U.S SEC is expected to rule on the matter in early 2024.
Another event that is differentiating bitcoin from the rest of the crypto world is this coming April’s “halving.” The system is set up so that the fee, in bitcoins, that miners get to create a blockchain block is halved every four years. In April, it is set to be reduced to 3.125.
Each of the last four halvings kicked off a big rally, where between 18 and 22 months out prices had risen between 500% and 7,000%. Then follows a drop of 74%, followed by an even slighter rally into the following halving. Most of the crypto miners and investors at October’s Alternative Investment Management Summit in Dubai said they were positioning themselves for the coming rally. It was notable that no one really knows why the halving kicks off the related rallies, although most of the crypto specialists at the AIM conference thought it was a supply constraint issue.
The options market has gotten the message and is sending the same signals about bitcoin. Ryan James Kim, head of derivatives at crypto prime broker Falcon X, wrote in mid-November, "expectations of how volatile BTC will be in 2024 have drastically reset from just 2 months ago. BTC options are saying that there is a much higher chance now of BTC going back to its all-time highs in 2024 than two months ago.”
Between the ETF and the technical bid from the halving, bitcoin looks like it should ride out the storm. But until the future for crypto exchanges becomes clearer, traders of other crypto assets will need to tread carefully, to avoid having prices move against them in this liquidity constrained environment.