The closure of Silvergate’s SEN and Signature’s Signet network in early March has created a liquidity crisis for the crypto market. While Bitcoin’s price has recovered since its March lows, topping out near $28,900, the initial dip still poses concerns for the market.
Poor liquidity around an asset leads to market inefficiencies, causing serious volatility and deterring sophisticated investors from placing trades.
Liquidity crisis poses significant risk
According to Kaiko’s head of research, Clara Medalie, the current liquidity situation is “pretty dangerous” and could result in massive price volatility in both directions. Medalie warns that “a drop in liquidity certainly helps traders to the upside, but there is always eventually a downside.” The moment buy pressure subsides, anything can happen to price.
The liquidity crisis first manifested with a $200 million drop in 1% market depth after Silvergate’s SEN network was closed, as identified in Kaiko’s latest research note.
The 1% market depth is calculated by summing the bids and asks within 1% of the mid-price for the top 10 cryptocurrencies. If the market depth is sufficient and order books are crowded around the market price, it reduces the volatility in the market.
The market depth for Bitcoin and Ethereum is still down 16.12% and 17.64%, respectively, from their monthly opening levels. Kaiko analyst Conor Ryder wrote that “we are currently at our lowest level of liquidity in BTC markets in 10 months, even lower than the aftermath of FTX.”
One measure of how easily the largest cryptocurrency can be bought or sold has fallen to 10-month lows. The liquidity dropoff is happening due to the firms that buy and sell crypto losing access to dollar-payment systems.
“Liquidity on US exchanges and USD pairs in particular have been hardest hit thanks to the banking fears,” Ryder said. It looks as if a big reason for the latest price rally in BTC was due to illiquidity, when depth is low, there is less support to not only the downside but also the upside as well.
What’s next for Bitcoin?
The ebb in liquidity has happened as Silvergate Capital Corp. and Signature Bank, which had deep connections to the crypto industry, have folded in recent weeks, with market-watchers on edge for any additional fallout or turbulence. It’s all happening as crypto prices skyrocket.
Bitcoin has surged roughly 70% this year, while other coins have also gained. Until some clarity appears in the US, we can probably expect more volatility in the short term, until we get that injection of liquidity that markets need.
“The same thing may be happening with stocks. Some of the large systematic traders have been triggers for heightened volatility,” says Aoifinn Devitt, CIO at Moneta.
Investors in the crypto industry are now eagerly waiting to see what happens next for Bitcoin. While the market has weathered storms before, this current liquidity crisis poses significant risks to the stability of the market. It remains to be seen whether Bitcoin’s rally will continue, or whether it will succumb to the liquidity crisis.
