Generally speaking, liquidity is the ability of an asset to be quickly converted into fiat money, that is, to be sold. The less value a certain asset loses in an accelerated sale, the more liquid it is. Illiquid property, for example, is considered to be real estate. And while flats do cost money, it can be very difficult to get rid of them, even in a month.

In the case of cryptocurrency exchanges, liquidity means the ability of the market to absorb large orders to buy and sell the asset at a stable price. A common metric for assessing liquidity is what is known as market depth, which is the volume of trades in a particular asset that will change its price by 2 per cent up or down. The greater the depth, the more liquid the asset is considered to be - and vice versa.


To understand what is going on, imagine the following situation. A trader holds a million dollars worth of bitcoins and wants to get rid of them instantly at $24,000 apiece. This requires buyers who will buy back the appropriate amount at the specified rate.

However, there aren’t enough willing buyers on the exchange for such a volume. Therefore, in case of market trade or using the so-called market order the exchange can sell BTCs for notional $300k at $24k, and the remaining amount of BTCs for $300k and $400k at $23.76 and $23.52.

The $23,520 is down 2 per cent from the original transaction level of $24,000. And since this is the last selling price in this situation, it means that the BTC specifically after this transaction will be worth $23,520 on a particular exchange. Accordingly, the market depth for Bitcoin on that exchange would be the million dollar level, because selling that exact amount of the cryptocurrency moved its rate by 2 percent.

It follows that the liquidity of cryptocurrencies depends on the number of traders who conduct transactions with them. However, if there are no willing buyers, then the seller will either have to wait for the limit order to be filled or sell the asset at a lower price.


Therefore, the less crypto-assets are on a particular exchange, the worse its liquidity will be. The exception to this might be a special working mechanism.

For example, the already familiar WOO X crypto exchange redirects orders from other platforms thanks to close cooperation with market makers, which provide liquidity for transactions. This provides a better trading environment, as a notional bitcoin seller on WOO X can essentially satisfy a buy order on Binance or another exchange. That is, technically, the liquidity here is accumulated from different platforms for a more suitable trading environment for traders.


What is happening with the cryptocurrency market

Data from analytics platform Kaiko shows that Bitcoin market depth for USDT pairs on the fifteen largest exchanges has fallen to 6,800 BTC, which is the volume of bitcoins that need to be bought or sold to increase and decrease the cryptocurrency by 2 percent respectively.

This is the lowest value of the index since May 2022. It’s down significantly from October highs above the 15,000 BTC line. Etherium’s market depth has more than halved to 57 thousand ETH since October.

What is the threat of low liquidity? Matthew Dibb, chief investment officer at Astronaut Capital, gave the answer. Here’s his rejoinder to what’s going on, cited by Coindesk.

Low liquidity will lead to sharp price movements – especially in altcoins. Funds trying to trade in large volumes are forced to use the TWAP mechanism over longer periods, i.e. days or weeks. Therefore, it seems that some asset charts have been “going up staircase” lately.


Recall, TWAP stands for "Time-Weighted Average Price", that is, a time-weighted average price strategy. It involves buying coins at a certain period of time for the required amount, i.e. dividing a large trade order into smaller batches and executing them at regular intervals.

This is usually done to minimise market impact or to reduce what is known as slippage - the difference between the expected price at which a trade was made and the actual price at which it was executed. With a TWAP strategy, big players can make the right trades at an acceptable rate. It does, however, take more time to do so.

The problem is that if any large investor now wants to sell a large enough volume of cryptocurrency, it will seriously affect its price. Dibb also believes that the low depth of the market suggests that there is an actual lack of the right amount of crypto funds in trading. That is, most of the activity in the market right now is individual traders with relatively little capital.

According to Blofin trader Griffin Ardern, what is happening in the market will lead to an explosion of volatility, meaning sharp changes in rates. Meanwhile, the Bitcoin Volatility Index (BVIN), which measures expected volatility over the next 30 days, has fallen to 56.39 points – its lowest level since early 2021. In other words, traders are now underestimating the possibility of a sharp rise or fall in the Bitcoin chart in the near term.

Crypto market liquidity began to decline in mid-November following the bankruptcy of cryptocurrency exchange FTX and associated trading firm Alameda Research. Alameda was one of the most prominent market makers, providing billions of dollars worth of liquidity for small and large tokens. Other firms, as well as popular market makers like Genesis and Digital Currency Group, were damaged by the events.

In addition, following the collapse of FTX, traders’ distrust of centralised platforms began to grow, causing them to withdraw coins to Ledger-type hardware wallets. This has also had an impact on liquidity, as the fewer crypto assets on exchanges, the fewer coins are available for transactions.

Also in this situation there is increased activity on decentralized exchanges, which is another result of the outflow of capital after the panic incident with FTX. The problem is not evident yet, but after another sharp market crash, new market makers will be forced into the game. Signs of that will be increased trading volume and other fundamentals.


We believe that the current situation is quite logical, given what has been happening in cryptocurrencies over the past year. While coins have now tentatively passed their price bottom of November 2022, user confidence in centralised platforms has not yet recovered from the FTX drama. Consequently, they prefer to store their own crypto assets off exchanges, which directly affects the liquidity of trading platforms. Time will tell how long this trend will last.