Liquidity Crisis In the Crypto Market: When Will It End? (2024)

Since inception, the crypto market has had its fair share of problems and remains unspared from the issues pertinent to the traditional finance markets. Mainstream adoption, price volatility, and issues around crypto taxing and regulation have stunted the growth of the market projected to be worth $10 trillion in 2030.

Recall thatBitcoin, in its early days, was surrounded by a wave of negativity, as financial experts predicted its collapse within a few years.However, today, it remains the leading cryptocurrency, paving the way for many other digital assetsthat contribute massively to the growth of the crypto ecosystem. Bitcoin's existence is also why many altcoins thrive today, as it remains the most adopted cryptocurrency.

Unfortunately, despite the success of the crypto space in recent years, the last 12 months could have been better. Top crypto assets, like Bitcoin and Ethereum, have plummeted in price value, contributing massively to the fall of the market capitalization of the space from the $2 trillion it was at the start of 2022. Other controversial issues, likeSam Bankman-Fried's FTX collapse, did not do the market any good.

However, one big issue that many analysts have discussed is the ongoing liquidity crisis, whose effect has been devastating on the crypto market. TheImmediate Edge websiteis a fair example of a platform that suffered from this effect. Even though the platform was doing tremendously prior to that, its numbers collapsed although the quality of the services provided is impeccable. Realistically, it is normal for markets to undergo liquidity issues, but the crypto market's liquidity crisis has overstayed its welcome. The lingering liquidity crisis has generated questions, as many are worried about when it will end. However, before we examine how long the ongoing liquidity crisis could last, it is crucial to understand what crypto liquidity means and its effect on the market's growth, performance, and future.

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Understanding Liquidity And How It Relates To Crypto

In finance, liquidity refers to how easily an asset can be bought or sold.Apart from measuring liquidity by how easy it is to trade(i.e., buy and sell) an asset, comparing its trading price (i.e., buying vs. selling) is also an excellent determinant to assess its liquidity. This means that if an asset has high liquidity, investors are confident they can sell it as easily as they purchased it. However, liquidity crises begin to occur when the market for such assets begins to freeze up, making it difficult to sell or trade them. When this happens, it increases the demand for liquidity, and the asset supply falls. The lasting effect of this scenario may lead to mass default and bankruptcy for all parties.

However, in crypto, liquidity refers to the ease at which token holders can quickly sell or trade a particular asset for either fiat currency or an alternate asset. A high liquidity asset is also associated with high trading volume, considering there is always a large pool of buyers and sellers trading it. An example of a high liquidity crypto asset is Bitcoin, which is readily available for purchase on exchanges and viapeer-to-peer, and investors can trade off anytime.

What Is A Crypto Liquidity Crisis, And Why Does It Happen?

Crypto liquidity crises occur when crypto exchanges and platforms lack the cash or convertible assets to help users finance their transactions. Most times, when users cannot trade, withdraw or even convert their digital assets due to a lack of liquidity, it signifies that bankruptcy is knocking.

In the crypto space, exchanges and trading platforms typically help users hold their assets and utilize them to run other transactions, from buying to selling assets, etc. Most times, keeping these assets for users is easy for all parties involved, as exchanges reward depositors (users) with high interests and mouth watering yields on savings.

Crypto platforms and exchanges are typically expected to hold a 1:1 equivalent cash value in proportion to assets via their bespoke algorithmic monetary policy. This affords them enough liquidity in their system and makes it hard to face a liquidity crisis. Unfortunately, when they cannot maintain this balance, it will lead to an uprising of problems centered around liquidity. Today, the two leading causes of liquidity crises are unexpected economic shocks and instability of business cycles.

A crisis can also develop when multiple financial institutions experience liquidity shortages and start to withdraw from their self-financed reserves.This will lead them to seek short-term financing from credit markets or sell their assets to create cash. Unfortunately, since many sellers will also try to sell simultaneously, interest rates will increase, and minimum reserve restrictions will become binding. The lasting impact will see the assets lose their value or eventually end up unsaleable.

Liquidity In Crypto; Why Is It Important And How Does It Benefit The Crypto Market?

Cryptocurrencies are primarily high-liquidity assets, which is why they are very marketable, and command high trading volumes. This is also why they are readily convertible to fiat currencies and alternate crypto assets. However, high liquidity is vital in the crypto market, as it mostly tells potential investors that the underlying asset is stable.

Fortunately, the crypto market benefits from high liquidity, as it gives room for more accurate pricing and charting. This allows analysts and investors to predict market outcomes and direction. Due to a large number of market players, high liquidity in the crypto market also aid the swift completion of buying and selling orders. This means that traders can quickly enter or quit a deal without delays.

Another benefit of high liquidity to a thriving market like the crypto ecosystem is that market players have access to better and fairer prices, as assets are seldom scarce and are always available. The high number of participants in the crypto ecosystem also means that the market can handle large orders while keeping prices stable.

When Will The Crypto Liquidity Crises End?

It is no news that the crypto market is currently down and in a liquidity crisis at the moment. The bulk of this crisis is due to the turmoil with Sam Bankman-Fried and FTX, which has left investors with losses. According to a recent report, the collapse of the world's third-largest crypto exchange has created a liquidity crisis that may extend well into mid-2023, bar a miracle.

After FTX filed for bankruptcy in November 2022, when it could not meet the number of unprecedented customer withdrawals it was getting at the time, many feared that the worst would happen to the crypto market.That announcement also led to many institutional investors confessing to having their investments on the platform.Unfortunately, that situation has deterred many potential investors, especially institutional ones, from committing funds to the crypto ecosystem.

In 2022, a report also showed thatstablecoins dominance reached a high of 18%, as investors were dumping crypto assets to buy more USD-pegged stablecoins. This further proves that the crypto assets are losing value, and investors would prefer to look away than commit funds. Surprisingly, the decline of the crypto market has now coincided with the bounce back of traditional markets that is currently in a better position.

According to a finance powerhouse Fidelity Management survey last year, institutional investment in cryptocurrency may likely increase in 2023. This is because, out of about 1,000 financial institutions surveyed, 74% admitted that they were pondering investing reasonable funds in Bitcoin. If and when this happens, it should provide more liquidity to crypto exchanges and trading platforms. If institutional investment in crypto increases, it will further improve crypto adoption, benefitting crypto exchanges, and the general market. Another added advantage of such investment is that it will instill confidence in current investors while attracting new ones. An increase in institutional investment in 2023 will also affect the market's fortunes and position it in a better place than in 2022.

However, while it is too early to predict, crypto analysts project that the current liquidity crises may extend until Q2 2023, as things still need time to look positive.