Is Bitcoin Heading Toward A Liquidity Crisis Without Equal?

It’s only recently that cryptocurrency has started to attract substantial attention from media, individual households, financial institutions, governments, and regulatory agencies, though it’s been around for more than a decade. Retail investors see digital assets as an essential component of their financial life, and as use cases beyond buy and hold are emerging, we can expect them to increase their holdings in the upcoming years.

Over 74% of accredited investors are allocated to tokens beyond top performers, borrowing against crypto assets and custody of NFTs.

However, some investors have seen this as an opportunity to track the BTC price and consolidate their portfolios. Buying low and selling high is the standard approach in the marketplace, and savvy investors know they should take advantage of price drops. But what do these trends have to do with Bitcoin’s future, and what can investors expect from the asset over the next few months?

As institutions and companies are actively investing in ETFs, they could disrupt the old equilibrium, causing the market to fall out of balance. When there’s a tremendous increase in demand and a decrease in the supply of liquidity, a crisis arises, making it hard, if not impossible, to sell cryptocurrency. Put simply, the cryptocurrency market doesn’t have sufficient cash on hand to meet demand without causing values to plunge. The scarcity induced would lead to unbalanced trades with increased volatility risks.

Low Liquidity Causes Capricious Price Moments & Poses Higher Risks For Participants

Liquidity is a feature of the cryptocurrency market by which an individual or an organization can immediately purchase or trade virtual currency without causing a radical change in its price. In other words, it’s a measure of how readily your tokens can be converted into cash.

Major cryptocurrencies like Bitcoin display higher liquidity owing to their extensive adoption – since there’s a large pool of buyers and sellers, you can secure a reasonable offer for your coins. With optimal liquidity, high trading volumes increase dramatically, reflecting the abundance of active traders and price stability.

While high liquidity reveals a dynamic market where Bitcoin can be exchanged promptly with little to no price slippage, low liquidity leads to wide and loose price swings, so investors get worse prices for their tokens. Regulators often create barriers to cryptocurrency trading, and their concern lies with the potential for fraudulent activities prevalent in gray markets. Limited trading volumes can render Bitcoin vulnerable to orchestrated schemes by small groups of people, which can give rise to pump-and-dump scenarios where the price is artificially inflated.

What Happens When There’s A Liquidity Crisis?

Recently, the digital asset analytics firm CryptoQuant pointed out a disturbing trend referred to as the “seller-side liquidity crisis”, which illustrates Bitcoin is slowly but surely approaching a point where demand will exceed the available supply. The arrival of spot Bitcoin ETFs catalyzed the latest surge in price by unlocking a wave of growth.

The outcome is that the liquidity is very low, meaning most traders are apprehensive and prefer staying on the sidelines, and the situation is so serious that the current stock of coins on the sell side can only support the demand for a maximum of twelve months.

Exchanges need liquidity to incentivize trading and guarantee a robust and stable trading environment. A liquidity crisis manifests itself when there’s a shortage of cash, making it challenging to meet immediate financial obligations, which can have far-reaching consequences, such as instability, resulting in losses for investors exposed directly or indirectly.

In a worst-case scenario, a liquidity crisis can generate bankruptcy, so you might not be able to withdraw your funds from a digital marketplace. As far as cryptocurrency is concerned, it’s necessary to drive natural growth and introduce more tangible use cases.

An increase in demand for a blockchain’s resources results in slower transaction processing times and higher fees, so cryptocurrency platforms hold a 1:1 equivalent cash value consistent with the assets. They equally deploy algorithmically governed monetary policy to preserve a one-on-one value, which improves liquidity but makes it hard to withdraw assets.

Even if the cryptocurrency market falls, investors can withdraw and sell their funds or wait for long-term value appreciation. Spot Bitcoin ETFs mainly source Bitcoin from within the United States, so it’s not surprising to see the Liquid Inventory Ratio setting a negative record.

For Bitcoin’s Bull Cycle To Regain Strength, A Rebound In Bitcoin Liquidity Is Essential

The overall amount of Bitcoin is very limited, namely 2.7 million BTC, which represents a significant drop from the all-time high of 3.5 million BTC in March 2020. The disproportion between the record-high demand and the unprecedented low in liquidity is apparent. During low liquidity, you can take advantage of limit orders to protect against excessive slippage, reduce the size of your trades, and buy cryptocurrency when there’s slightly more liquidity. The idea is to use strategies that mitigate risks while exploiting opportunities.

If wallets from Bitcoin’s early days wake up, a great many coins could return to circulation, relieving the pressure on exchanges to prove their resilience. The cryptocurrency sector is hurting and needs help to make it through the winter. Digital assets move at a fast pace, meaning it’s vital to plan early so you can act when required, as you have more options available. Consider all the available solutions, create short- or medium-term roadmaps, and keep a positive mindset. Every decision you make sets the tone for the life you’ll lead.

Wrapping It Up

As an institutional investment, Bitcoin is just getting started, so ETFs keep developing, and it’s becoming less likely they’ll stop anytime soon. Nonetheless, if things continue this way in the long run, there may not be enough BTC to satisfy demand, which means that Bitcoin’s success could be its downfall. One approach to enhancing liquidity is to use DeFi protocols or liquidity pools because they stabilize and enhance market depth. As the cryptocurrency market matures and more players enter, cash needs must be continually met.