Investing.com - The cryptocurrency sector continues to experience weeks of intense volatility. Bitcoin is trading around $25,000 and Ethereum around $1,600. This type of volatility is undoubtedly affecting liquidity.
"The spot volume traded in cryptocurrencies has fallen off a cliff over the last year and a half as the market struggles to find its role in the current high interest rate environment. In addition, after Silvergate Bank and Signature Bank (OTC:SBNY) ceased operations, market makers may not be able to operate as efficiently as before," warns Mads Eberhardt, cryptocurrency analyst at Saxo Bank.
"Since the end of the cryptocurrency market's run in 2021, its liquidity has dried up. As an illustration, spot trading volumes on both Coinbase (NASDAQ:COIN) and Kraken, the two main fiat money on-ramps for most of the world, have plummeted over the past two and a half years. Last May saw the lowest combined trading volume of these two exchanges: some $39 billion. Two years earlier, this figure was $369 billion," Eberhardt adds.
In general, according to Eberhardt, less volume equals less liquidity. "From the beginning of this year until mid-June, Coinbase's market depth decreased by around 25%, while Kraken's liquidity improved slightly, according to cryptocurrency platform Kaiko. Worse liquidity means there are fewer participants in the market and less volume is needed to move the needle in terms of price, especially if larger sizes are traded," Eberhardt explains.
Lack of liquidity when the market needs it most
"There have also been sudden free falls in liquidity due to contagion effects. It happened, for example, when FTX and its hedge fund Alameda Research collapsed. During such a contagion, the market needs liquidity more than ever, so abrupt liquidity shortages in these cases have a very negative impact on the market, because it fuels excess volatility and an inefficient market when it is already on high alert," says Eberhardt.
The latest cryptocurrency contagion occurred in March this year, when Silvergate Bank, Signature Bank and SVB (OTC:SIVBQ), all of which are related to cryptocurrencies in one way or another, ceased operations. The cryptocurrency market has been somewhat quiet since then, although to be sure, further contagions cannot be ruled out. Should this be the case, market participants must recognise that liquidity could immediately fall off a cliff and act accordingly, as a liquidity drop similar to the FTX collapse is not unlikely, Eberhardt reminds.
"This is a particularly feasible outcome considering that market maker market conditions are worse than they were at the end of 2022 due to the absence of Silvergate and Signature, through which market makers could instantly deposit and withdraw dollars and euros to and from exchange accounts to benefit from arbitrage and subsequently maintain an efficient market. Alternatives to Silvergate and Signature have emerged in recent months, but they are nowhere near as popular as the other two banks were. This means that current liquidity is further endangered by contagion and volatility," concludes the Saxo Bank analyst.
Translated from Spanish using DeepL.