Kaiko: Liquidity crisis causes major price drops during cryptocurrency sell-off

The cryptocurrency market is facing a growing liquidity crisis, as evidenced by the significant price drops during recent sell-offs.

According to research by Kaiko, the ongoing problem of liquidity fragmentation on crypto exchanges has led to noticeable price discrepancies, especially during times of market stress.

Price slide

Liquidity fragmentation is the uneven distribution of liquidity across different exchanges. The recent market sell-off has brought these issues to the forefront, with BTC prices on Binance.US diverging from those on more liquid platforms.

Binance.US, a platform that has been struggling with liquidity issues since the SEC lawsuit in June 2023, has seen its daily trading volume plummet from $400 million in early 2023 to just $20 million today.

The drop in liquidity has made the platform particularly vulnerable to price discrepancies during market events, such as the August 5 sell-off. During this event, less liquid altcoins experienced even greater price discrepancies, adding to the challenges for traders.

Price slip, an indicator of liquidity, tends to increase during market sell-offs as liquidity dries up, making it harder to execute orders at desired prices. Kaiko’s data shows that price slip increased on most exchanges on August 5, with certain platforms and trading pairs experiencing stronger spikes.

For example, Zaif’s BTC-JPY pair faced the highest slippage due to the Bank of Japan’s interest rate hike, while KuCoin’s BTC-EUR pair saw deviations of over 5%, highlighting the risks for traders in less liquid markets. Even normally liquid stablecoin pairs like BitMEX and Binance.US’s USDT and USDC pairs were not immune, with slippage increasing by over three basis points.

The impact of liquidity events can vary not only between exchanges but also within trading pairs on the same platform. For example, Coinbase’s BTC-EUR pair is significantly less liquid than its BTC-USD counterpart, leading to extreme volatility during times of intense market activity.

This became evident in March when Coinbase’s BTC-EUR price deviated sharply from the broader market, resulting in a significant drop in market depth.

Trading boom on weekdays

Another factor contributing to the liquidity crisis is the concentration of trading on weekdays, especially in the BTC-USD markets. This trend, exacerbated by the launch of US spot ETFs, increases volatility on weekends. Unlike traditional markets, crypto markets operate 24/7, so Friday sell-offs can exacerbate weekend uncertainty and amplify price impacts.

During the recent sell-off, Bitcoin price fluctuated 14% between Monday’s open and Friday’s close, consistent with moves seen during major sell-offs since 2020.

Despite the challenges of liquidity fragmentation, Kaiko points out that crypto platforms have invested significantly in infrastructure to handle higher trading volumes without outages, thereby reducing arbitrage costs between exchanges.