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Bitcoin - the risk of a decrease in liquidity is increasing. How might this affect prices?
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Bitcoin - the risk of a decrease in liquidity is increasing. How might this affect prices?

created Daniel Kostecki28 March 2023

Withdrawals of cryptocurrency exchange clients from exchange accounts, transfers to private wallets, limited access to traditional banking, the collapse of Alameda, the return of BTC trading fees on the Binance exchange, and many other factors may contribute to the picture of a decrease in liquidity on the crypto market.

As reported by the Reuters agency, the depth of the bitcoin market indicates that BTC is at its lowest liquidity level in 10 months, even lower than following the collapse of FTX in November. Market depth for the two leading pairs BTC / USD and BTC/USDT – is 5600 bitcoins, which is equivalent to approximately $155 million.

The slip has doubled

Slippage, a measure of liquidity that describes how much prices change between placing and executing trades, has also increased, Reuters added. Slippage for purchase of bitcoin per USD on the Coinbase exchange is 2,5 times higher than in early March, said Conor Ryder, an analyst at Kaiko. The slippage for a simulated $100 sell order has doubled in the last month, meaning the average price you get for each bitcoin is worse than it was a month ago.

The liquidity problem was greatly spread by the collapse of Silvergate Capital and Signature Bank, whose networks had long been exploited by market makers - who they increase liquidity by quickly buying and selling tokens - for transactions with exchanges.

Lower liquidity usually translates into more volatile markets, especially in cryptocurrencies. CryptoCompare's Bitcoin Volatility Index rose to 96 last week, much higher than the 52-65 range it saw last month. Another liquidity constraint is Binance, the world's most liquid cryptocurrency exchange, which ended fee-free trading for nearly all BTC pairs last week, striking the ability of market makers to charge higher fees to complete trades on the platform.

Disappearing liquidity can also be associated with a fall FTX exchanges Sam Bankman-Fried and the hedge fund Alameda Research. Alameda was one of the largest liquidity providers in the cryptocurrency industry, and hers bankruptcy left a void, which was deepened by the turmoil in the banking sector.

How can less liquidity affect prices?

First of all, with lower liquidity, higher volatility may appear. With "holey" order sheets relatively small capital is enough to move the price in an above-average way. Recently, the problem of liquidity has been experienced by the bond or interest rate market. We saw then how much prices can change in such important markets.

In the cryptocurrency market, this may be even more likely. Therefore, you can prepare for the fact that the coming period may be much more volatile in the crypto market than before.

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About the Author
Daniel Kostecki
Chief Analyst of CMC Markets Polska. Privately on the capital market since 2007, and on the Forex market since 2010.