Liquidity in the crypto market remains a major challenge. The recent introduction of Bitcoin (BTC) and Ethereum (ETH) exchange-traded funds (ETFs) in the United States had raised hopes of improvement. However, according to Kaiko’s latest report, these expectations have only been partially met. Despite an increase in trading volumes on major platforms since November 2022, the reality is that the market remains fragile and vulnerable to sudden fluctuations. This report highlights two areas of reflection: the limited impact of ETFs on true market liquidity, and structural issues.
The limited impact of ETFs on the liquidity of crypto markets
Published on August 29, 2024, Kaiko’s report states that the introduction of Bitcoin and Ethereum ETFs has raised hopes of improved liquidity in crypto markets. Since the collapse of FTX in November 2022, a 30% increase in daily trading volume has been seen across the top ten crypto exchanges. However, this increase does not necessarily translate into sufficient liquidity to absorb large orders. Indeed, the report points out that trading volume, while an indicator, is not an absolute measure of liquidity. It can be inflated by activities such as wash trading or incentives offered by trading platforms.
Kaiko insist on the importance of “market depth,” which measures the ability of a market to absorb large orders without causing significant price movement. The volume/market depth ratio is proposed as a more reliable indicator to assess true liquidity. To date, even with the increase in trading volume, the crypto market is not yet ready to face major impacts, as evidenced by the recent market crash on August 2nd after an unexpected rate hike by the Bank of Japan. This event led to significant “slippage” on Bitcoin orders, with trading pairs like BTC-EUR on KuCoin seeing slippage exceeding 5%.
The market remains under pressure due to supply overhangs
Beyond the limited effects of ETFs, Kaiko’s report highlights other challenges. A key factor is the “supply overhang,” or the presence of large stocks of cryptocurrencies that could be liquidated in the market. For example, the Mt. Gox legacy, with its 46,000 BTC yet to be redistributed, poses a permanent sword of Damocles. Each successive distribution triggers a new wave of selling, creating further disruptions in the market. In addition, many governments, including those of the United States, China, and Ukraine, hold large amounts of Bitcoin that they could choose to sell at any time, amplifying the risks of volatility.
These potential sales, combined with already limited liquidity, exacerbate the risks of high slippage and unexpected price movements. Kaiko’s report notes that these market dynamics make it difficult for even the most seasoned investors to predict and manage risk. Furthermore, the variation in liquidity levels throughout the day, with particularly pronounced periods of low liquidity, reflects a lack of robustness in the current market structure.
While the introduction of Bitcoin and Ethereum ETFs has provided some improvement in liquidity, issues (particularly the liquidity squeeze) persist for the crypto market. Between supply overhang risks and fragile market depth, the sector remains vulnerable to shocks.
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