The Liquidity Crisis in Crypto Ecosystem

CrossFi_Official
3 min readDec 29, 2022

In this current age of crypto and blockchain rave, the term “liquidity” has been thrown around a lot. Even a newbie to the crypto space isn’t spared of the cut. In the crypto domain, liquidity accounts for the simplicity with which a digital currency or token can be exchanged for an asset or cash without fluctuations in price taglines.

Since liquidity tends to measure the totality of an asset’s external supply and demand, it serves as proof of a healthy market. Simply put, the more liquidity present in a crypto or virtual asset, the more stable and less volatile the asset will be.

Liquidity in the crypto market, in other words, represents high trading volume. This means that you can buy and sell any desired quantity of the virtual asset without any glitch, any time you want, without having to worry about declination in the asset’s value below the main cost. The availability of multiple buyers and sellers leads to high liquidity, which in turn provides better price costs for users. Most importantly, liquidity rise also ensures that prices are stable and resistant to external influences that cause price variations including large market orders.

Marketplaces and digital trading platforms need liquidity to engage in trade — buying, selling, and transferring. Although most crypto investors often choose to store their assets in these exchanges because they offer varied interest rates and substantial returns.

Everything You Need to Know About Liquidity Crisis in the Crypto Ecosystem

A crypto liquidity crisis occurs as a result of a lack of cash, or assets that are convertible to cash. Having crypto in exchange allows you to finance all your transactions from trading to buying to withdrawal. Once there are little or no resources and funds needed to support a transaction — let’s say, to change Bitcoin (BTC) to Tether (USDT), or Ethereum (Eth) to USDT — there’s an undeniably hard problem. Because a lack of liquidity leads to a deep dive into bankruptcy and financial breakdown, you risk losing all the money you have on these exchanges.

Liquidity problems happen when sources of liquidity are no longer reliable, exhausted, or facing an immediate halt. For instance, if a bank goes ahead to freeze or stop providing credit loans, most businesses that are dependent on these loans to face their obligations are affected, causing a kind of chain reaction.

A major example is the recent news-worthy insolvency of Sam Bankman-Fried’s biggest exchange platform FTX, which has led investors as well as traders on the exchange to lose most of their assets in a single day and was also a pin-prick for many crypto ecosystems smacked by them.

Another example is the collapse of Vauld, a Singaporean crypto lending and exchange platform, that halted their operations, which consequently led to the financial troubles of Celsius Network, Terra, and Three Arrows Capital.

How Liquidity Crisis Impacts Crypto Investors

Liquidity crisis often occurs as a result of unforeseen economic shocks and fluctuating business cycles. In the recent event of the FTX collapse, in which investors lost most of their savings, many DeFi companies backed up by them were heavily affected, and this harmed the market.

FTX has grown over the years to become one of the biggest and most prominent players within the cryptocurrency space, attracting many clients. Much that it had hit a valuation of $32 billion at the beginning of the year, gathering blue-chip investors such as BlackRock and Softbank.

FTX’ troubles, however, escalated when Bitcoin, its major competitor in the market, announced that it would offload its holdings of FTX’s token, FTT, as a result of concerns over the exchange’s financial stability and price fluctuations. And since investors were quite worried that their money may be locked up forever in the exchange, they had to pull out their money up to the moment when FTX halted its bidding over an extreme market break-down.

Conclusion

Crypto liquidity remains an essential factor used by investors to consider which projects are worthy of their investment. And it can only grow through increasing acceptance among investors.

CrossFi is a cross-chain protocol that provides liquidity for Filecoin staking and rewards.

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