Q2 Crypto Liquidity Update

While CeFi liquidity has been on a gradual decline this year, which will be the main focus of this article, DeFi is facing a liquidity crisis of sorts in the last few days as one of the most liquid pools in the space becomes heavily imbalanced, so we’ll start there.

DEFI Liquidity

After the latest round of fears surrounding Tether, the 3pool moved to a weight of 75% Tether in the last day, as users rushed out of crypto’s largest stablecoin at once. This resulted in Tether depegging to a price of $0.996. This is the most imbalanced the Curve pool has been this year.

Curve has also been in the news as its founder comes under fire for his huge position on Aave which has seen him borrow $65m worth of stablecoins by depositing over $166m worth of CRV tokens, depositing more in the last few days to safeguard against the possibility of the loan being liquidated. This position has led Aave’s risk management advisor, Gauntlet, to propose freezing CRV on Aave and setting its LTV to 0 due to the 50% decrease in CRV liquidity over the past few months, fearing the potential of the protocol being left with bad debt in a liquidation scenario.

CRV liquidity off-chain has seen a big drop off over the last year, with 2% ask depth down from a high of $3m a year ago to below $1m now.

The majority of CRV volume is on CEXs, and the built up loan position presents an interesting dilemma. It’s important that Aave governance voters account for the lack of liquidity on the centralized exchange side, which does pale in comparison to the size of the loan.

CEFI Liquidity

Centralized liquidity has been hit as hard as anything this bear market as regulatory and banking issues have driven the likes of Jump and Jane Street to retreat from offering liquidity in the US while global liquidity also falls. Market makers leaving the US is to be expected given the unfavorable regulatory environment, but so far in 2023 that liquidity hasn’t been replaced, with total market depth for crypto’s top 10 tokens down 20% year to date.

Market Depth

Interestingly BTC liquidity has been one of the hardest hit, falling from 14k BTC within 1% of the mid price at the start of the year to just over 9k today. More encouragingly, this quarter has seen a slight improvement in depth on BTC order books, increasinging from 8k to 9k over the quarter.

Out of the top 10 tokens, MATIC, BTC, SOL and TRX have suffered the most from a liquidity standpoint. Clearly, market makers are taking precautionary measures by pulling their liquidity for these tokens from order books, no matter the short term developments from the SEC lawsuits that claim some of these tokens are securities.

XRP has actually had the smallest drop in liquidity, down about 10% on the year, perhaps indicating market makers are taking an optimistic outlook for Ripple in their case with the SEC.

Exchange liquidity is also something to keep an eye on with exchanges like Binance.US and Coinbase in the news seemingly every other day this quarter. U.S. exchanges have had to deal with an increasing amount of scrutiny from regulators and market makers have announced withdrawals from the region as a result. However, depth for exchanges offering USD pairs has actually been more resilient than their more global counterparts, with depth down just 14% compared to 20% for the more global exchanges.

However, zooming in on some of the exchanges in the headlines shows us that the exchanges with the biggest drop in liquidity are those which have faced logistical challenges due to regulatory enforcement in the U.S.: Bittrex, Binance.US, and OKCoin liquidity is down at least 75% each. OKCoin have their USD deposits shut down after the closures of Silvergate and Signature, while Bittrex and Binance.US have had their own battles with the SEC of late, with Bittrex declaring bankruptcy and market makers retreating from Binance.US.

In better news for crypto liquidity in the U.S., Kraken was one of the only exchanges tracked that had an improvement in liquidity, both for Q2 and year to date. Coinbase and Binance liquidity is down about 25% on the year so far.

Volumes

As market makers pull orders from order books and begin scaling back their operations, volumes have been suppressed in Q2 and have hit their yearly lows at times. Average daily volumes for Q2 have been only $10bn for the top 10 tokens excluding stablecoins, compared to a daily average of $18bn in Q1, reflecting the even worse liquidity situation now in the industry.

Looking from a token standpoint, market share of volumes have shifted in Q2, with BTC losing about 20% market share since its peak at the end of March. Since its lows at the end of March, ETH’s share of volumes is up over 5%, while BNB’s share has spiked in the last few days amid the Binance fears, rising from 2% of volumes to over 7%.

Exchange market share of volumes has been volatile over the quarter with the backdrop of a hostile US regulatory environment. One of the most notable changes in market share was Binance.US, dropping from over 5% share of volumes at the end of March to 0.6% of volumes today as the exchange all but grinds to a halt in the wake of the SEC’s suit.

Other exchanges have doubled in share from 5% to 10% in what is probably a healthier indicator for the market, while Binance lost 10% of share, making market share a bit more distributed across exchanges and reducing Binance’s monopolistic influence on the market.

Spreads

My last Deep Dive focused on bid ask spreads, and more specifically the volatility of spreads on each exchange. Binance.US was again singled out as one of the exchanges with the widest distribution of spreads, and those spreads have understandably become even more volatile with the lawsuit from the SEC and market makers leaving the exchange. Real spreads on the exchange’s BTC-USD pair almost touched 3bps, their highest this year, as liquidity worsened.

With worsening liquidity on the exchange’s flagship pair the outlook for Binance.US appears bleak before they get any more clarity on their regulatory issues.

In order for the market to sustain any meaningful rally going forward, liquidity must improve, and for that to happen investors are still waiting on any positive news on the regulatory front. That doesn’t look likely to happen any time soon in the U.S., so there is a serious opportunity for regions elsewhere to capture significant market share in the industry.