Bitcoin’s Big Moves Are Being Magnified by a Protracted Lack of Liquidity

A protracted dearth of liquidity in cryptocurrency markets is playing a key role in the more than 10% swings in the price of Bitcoin seen in recent weeks. 

Market depth remains at its lowest point this year even with the recent resurgence in trading activity being spurred on in part by expectations for a Bitcoin exchange-traded fund, FalconX’s research team found. They measure market depth by looking at the average volume of Bitcoin trading activities within 1% of its current price, on a 24-hour basis. 

The drop in overall liquidity was dubbed the “Alameda Gap” last November by blockchain-data firm Kaiko. Alameda Research was the trading arm of Bankman-Fried’s failed FTX digital empire. The lingering effect is largely a result of the huge losses that market makers incurred after the meltdown of FTX, according to researchers at Kaiko. Bankman-Fried’s fraud trial resumes today.

On Oct. 16, Bitcoin jumped more than 10% in a matter of minutes as false report circulated saying that the US had approved a long-awaited ETF that invests directly in the cryptocurrency. It erased most of that increase just as quickly when BlackRock said its application was still with the SEC. 

A similar spike was seen on Oct. 23 as traders speculated that a possible listing of a ticker for the proposed BlackRock fund suggested approval was imminent. The combination took Bitcoin above $35,000 for the first time in about 18 months. Bitcoin was little changed at about $34,540 in New York on Monday.

“It is difficult to ascribe a single narrative to the recent rally,” said Juthica Mallela, head of over-the-counter options trading at crypto exchange Kraken. “It is possible that the price movements stem from a combination of market positioning, spot buying, and a broadly positive macro landscape for Bitcoin which includes a spot Bitcoin ETF on the horizon.”

At the same time, Patrick Chu, head of institutional sales coverage in Asia Pacific at Paradigm, a liquidity provider for crypto derivatives, noted that the company had two days of record volume the past week at above $2 billion. 

The “market has picked up massively in the last week as volatility comes back to life,” Chu said. “Market short gamma above $30K in BTC-driving price action, a lot of guys covering risk.”

However, on the spot market, the total trading volumes across centralized and decentralized exchanges are at multi-year lows, according to data compiled by crypto research firm Delphi Digital.

The market capitalization of stablecoins is another measurement used by analysts to gauge the health of the liquidity in the market, since stablecoins are used as key on- and off-ramps for crypto traders. They’re usually pegged to another currency, most often the dollar. The total market capitalization of stablecoins has been shrinking, according to data from tracker DeFiLlama. 

One reason that the digital-asset market is not attracting new money could be the rising interest-rate environment. Decentralized finance, whether it’s peer-to-peer lending or automated market makers, once wooed investors with their promises of double- or triple-digit returns in an ultra low interest rate environment during the Covid-19 pandemic era. Now they are struggling, as yields in traditional finance are more attractive, and less risky.

“The fundamental reason why liquidity continues to flow out, as opposed to into crypto markets, is because of the high interest rates,” Michael Rinko, an analyst at Delphi Digital, said in a direct message.