Crypto liquidity on the buy side is down 52%, putting traders at risk

The cryptocurrency market has become increasingly uncertain. The recent legal actions taken by the Securities and Exchange Commission (SEC) against crypto exchanges such as Binance, Binance.US, and Coinbase have thrown crypto liquidity into crisis.

These regulatory measures promote an environment characterized by instability and heightened risk for traders.

Market Depth of Top 10 Cryptos Plummets

A critical aspect of the SEC’s allegations concerns crypto exchanges that offer trading in unregistered securities. These include Solana (SOL), Cardano (ADA), and Filecoin (FIL), just to name a few.

The fees, which were first voiced at Bittrex, have been extended to Binance and Coinbase. The lawsuits point to significant growth in altcoin trading volumes over traditional favorites like Bitcoin and Ethereum.

“The growth in quarterly volumes [for Binance.US] was astounding, jumping from $5 billion to $42 billion to $106 billion in just three quarters. Notably, altcoin volume exceeded BTC and ETH volume combined for the entire bull run, which is highly unusual for US exchanges,” Kaiko Quarterly Report reads.

The impact of these charges has led to a drastic reduction in liquidity across all crypto trading platforms.

Market depth, an essential measure of liquidity, has suffered significantly. In particular, Binance.US’s liquidity continued to decline after the charges, even though Binance recovered somewhat.

On-chain data paints an even more worrying picture. Bittrex, Binance.US, and OKCoin have all seen their market depth drop significantly for the top ten cryptocurrencies.

Bittrex’s depth is down 68%, while Binance.US and OKCoin have both suffered an 85% drop since the start of the year.

The drop in crypto liquidity is also symptomatic of other issues. For example, OKCoin, following a temporary suspension of USD deposits amid a banking crisis, has struggled to restore liquidity due to the unavailability of alternatives.

Bitcoin Exchange reserves are approaching two million BTC

In addition, Bitcoin’s global liquidity dropped by more than $10 million in the second quarter of 2023.

This is a worrying trend exacerbated by the decision by key market makers Jane Street and Jump to scale down their liquidity operations in the US.

Ki Young Ju, CEO of CryptoQuant, maintains that the liquidity crisis that cryptocurrency exchanges are experiencing is even more notorious when looking at the sell-side and buy-side liquidity of the two largest cryptocurrencies by market cap and all major stablecoins.

“Crypto liquidity on the sell side [is] falling, but buy-side liquidity is falling even more sharply. BTC exchange reserve down 20% in a year, ETH down 40%, stablecoins down 52%,” said Ju.

This declining liquidity poses a significant risk to traders. Low liquidity allows market manipulators to exploit asset prices, creating fluctuations that enable “pump and dump” schemes.

Traders also face “slippage”, where the difference between asset target and actual execution prices can lead to unexpected losses. Finally, crypto traders may struggle to exit positions due to a lack of counterparties on exchanges with low liquidity.

Risk management is key

However, it’s not all doom and gloom. Traders can take several steps to mitigate the dangers of low liquidity. Trading on exchanges with high trading volumes and narrow spreads can provide more stability.

Monitoring market depth and order books can help crypto traders gauge liquidity levels, while using limit orders instead of market orders can minimize slippage. Finally, diversifying trading activities across multiple crypto exchanges can help avoid overexposure to a single platform.

While the trading landscape has undoubtedly become riskier due to declining crypto liquidity, these challenges are not insurmountable. Traders should stay informed, use reliable platforms and use smart trading strategies to navigate the current uncertainty in the crypto market.