During the current market downturn, the cryptocurrency industry is facing a significant liquidity crisis. According to Kaiko’s research, liquidity fragmentation across various crypto exchanges exacerbates this problem during market sell-offs. In recent events, especially during the August 5 sell-off, large price differences and shifts between exchanges have been observed.
Liquidity Fragmentation and Price Slippage: Current Concerns
Liquidity fragmentation refers to a situation where liquidity is unevenly distributed across exchanges, and this problem is becoming increasingly apparent. This leads to increased price slippage during market sell-offs. Price slippage occurs when the actual exchange price differs from the expected price due to insufficient liquidity. During the market stress on August 5, price differences were particularly pronounced. For example, Binance.US reduced its daily trading volume from $400 million to just $20 million following the SEC lawsuit in June 2023. This increased the price deviations of less liquid altcoins on the platform, making trading conditions difficult.
According to Kaiko data, liquidity was significantly reduced on many platforms during the events of August 5, resulting in increased price slippage. These slippages exceeded 5% on Zaif’s BTC-JPY pair and KuCoin’s BTC-EUR pair due to the Bank of Japan’s interest rate hike. Even on exchanges with high liquidity, such as BitMEX and Binance.US, slippages of three basis points were observed on stablecoin trading pairs such as USDT and USDC.
Even within a single platform, significant liquidity differences can occur between different trading pairs. For example, Coinbase’s BTC-EUR pair is much less liquid than its BTC-USD pair. This inherent difference can lead to greater volatility during busy market periods. The sharp divergence in Coinbase’s BTC-EUR price in March resulted in significant reductions in market depth.
Another factor that further exacerbates the liquidity crisis is the intense trading activity during the week, especially in the BTC-USD markets. The launch of US spot Exchange Traded Funds (ETFs) is causing more volatility on weekends. Since crypto markets are open 24/7, weekend sell-offs can lead to huge uncertainties and price swings. For example, during the recent sell-off, bitcoin saw a 14% price move between Monday’s open and Friday’s close, mirroring the patterns of the major sell-offs seen since 2020.
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