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Low liquidity, a problem that has plagued the cryptocurrency market since the collapse of FTX in November, could increase price volatility as regulators crack down on dominant exchange Binance.
On Monday, the US Commodity Futures Trading Commission (CFTC) sued Binance for operating “illegal trading” and a “fake” compliance program. The regulator responsible for overseeing commodity and derivatives markets, including bitcoin (BTC)-related derivatives, has sued Binance CEO Changpeng Zhao and former senior executive Samuel Lim for alleged " intentional evasion" of US law.
Binance has long been the leading exchange for digital assets and holds a larger share of global trading volume than its former rival FTX. According to Morgan Stanley, exchanges accounted for 81% of the total BTC traded on centralized exchanges in February. According to the filing, the trader from Chicago accounted for 12% of the total trading volume on Binance.
Thus, observers fear that the cause could lead to a sharp decline in market liquidity, a measure of how difficult or easy it is to trade large volumes at fixed prices.
“The biggest concern is what this will do to market near-term liquidity: If market makers stop trading on Binance now and Binance's US-based trading banks have to shut down, it will reduce liquidity in a market already weak,” says Noelle Acheson, author of the popular Crypto is Macro Now newsletter.
"It will increase volatility and keep some big players away for a while," Acheson said.
Liquidity is largely measured by a measure called the 2% market depth: the accumulation of buy and sell orders within 2% of the average price, or the average of the bid and ask/bid prices.
The deeper the market, the less likely it is that large buy/sell orders will cause large deviations in the market price of the asset. Market makers are institutions that provide liquidity to the financial market by creating buy and sell orders that are not filled immediately.
© CoinDesk Bitcoin liquidity, as measured by order book depth, hit a ten-month low on March 13.Bitcoin's market depth of 2% fell to a ten-month low last week, compounded after FTX's sister company, Alameda Research, formerly a major market maker, closed its doors five months ago.
According to Cumberland, a subsidiary of DRW, this situation will last for some time, one of the oldest and longest in the cryptocurrency market.
“This case will undoubtedly increase rigidity and weaken liquidity in an already strained digital asset banking system,” Cumberland said in a tweet explaining the impact of the regulatory action on the market.
Some observers are expecting Bitcoin to revise the support that cleared the resistance near $25,000 amid growing regulatory uncertainty.
“It is clear that the CFTC wants to monitor all cryptocurrency exchanges. This is nothing new, but the market is cautious and we always hold our breath for more negative news that could send BTC down,” Ksis told CoinDesk.
Yesterday's surge in long shares [liquidation] will inevitably push the price lower, perhaps below the support around $25,000,” Ksis added.
Bitcoin fell more than 3% on Monday to a low near $26,500 in response to CFTC action against Binance. The cryptocurrency has since stabilized around $27,000, hitting a nine-month high of $28,889 on March 23, according to data from CoinDesk.
Derivatives trades liquidated or forced $25 million in bullish long positions on Monday, a sharp increase from Sunday's figure of $3.6 million. Meanwhile, the short-term settlement amount is only $7 million. Forcing out of long/short positions often adds bearish/bullish pressure on cryptocurrencies.
According to Acheson, the lawsuit is not good news for equity valuations because it "adds another layer of uncertainty and follows another high-profile fraud, not a good 'look' for the ecosystem."
However, Acheson anticipates recent macro developments, such as growing expectations of a faster Fed turn towards rate cuts in the market due to the negative impact of Binance news.
“For BTC, ETH and other majors, we are seeing sustained selling interest from incoming buyers – it's a very different market than November, with a pivot in sight and new details inspiring new investment decisions,” he said. Acheson. “Psychologically speaking, this FTX is a blast. This is no shocker, as the market has been repeatedly warned that something like this is coming.