As Bitcoin liquiduity is drying up, threatening market stability, we cannot help but wonder: have the HODLers been doing it wrong all this time?
Long gone are the times when Bitcoin’s behavior was determined solely by its users. It is now a world-class asset, and as such, it is subject to the rules of financial markets.
Understanding these rules is essential not only for deciphering crypto-related events, but also for preparing ourselves for price fluctuations, and even adopting a better approach to managing our own BTC.
D.Center is here to help you make sense of financial notions as they apply to the crypto space, and in this newsletter, we would like to shed light on a key notion of the Bitcoin market – its liquidity.
The term “liquidity” is increasingly mentioned in various market analyses, to the point that some experts have even started sounding the alarm about insufficient liquidity and the price drop it might trigger soon.
Let’s delve into the state of Bitcoin liquidity and the forces that influence it, including the day-to-day actions of an average bitcoin HODLer. But first, what is liquidity, and why it’s so important?
One of the most important metrics for any market, liquidity measures the ease with which an asset can be bought or sold without significantly affecting its price.
For example, Apple stock is a highly liquid asset: an average of 56 million $AAPL shares is traded on Nasdaq every (bank) day. This makes price discovery easy, as thousands of buyers and sellers are determining what an $AAPL stock costs at any given moment. A Picasso painting is not a liquid asset: its owner cannot sell it at any time, and its price is determined solely by the last buyer.
Liquidity is essential for the smooth functioning of financial markets because it allows investors to enter and exit positions easily and facilitates the price discovery process.
If a market is not liquid enough, any large buy or sell market order will result in a significant price swing.
Imagine someone who has to sell a substantial amount of BTC immediately: at first, the order will be filled by the buyers willing to pay the current price; when these buyers are exhausted, the rest of the order goes to the buyers who offer a smaller price, and then a smaller still… The price is going down, possibly triggering liquidation events for derivatives and leveraged traders, inducing a downward spiral.
Of course, this mechanism also works in the opposite direction, and a massive buying order in such a market will inevitably drive the price up. This makes the low liquidity situation both a blessing and a curse.
The number of buy and sell orders available at different price levels is called market depth, and it is one of the key notions determining asset liquidity. The deeper the market, the healthier it is, allowing to fill in increasingly big orders.
Bitcoin is a liquid asset. Anyone can go to Coinbase or Kraken and easily exchange their $BTC for $USD.
According to Blokchain.com, Bitcoin’s daily trading volume,another key liquidity metric, currently stands at $67 million on major exchanges. Indubitably, it’s a far cry from the record $1.65 billion at the heights of the 2021 bull market, but it’s still an important number. So, where do all the concerns about its liquidity come from?
As a matter of fact, these concerns primarily stem from the dynamics, which shows the market becoming more apathetic. Future prospects, influenced by the rising interest rates and liquidity concentration, also come up quite often.
While we agree with both these considerations, we would also like to add an important factor, which is market actors’ behavior, and more precisely – the famous HODLing mindset.
The more expensive it is to borrow money, the less people are keen on investing, and the less liquidity is there in the markets.
Bloomberg analyst Mike McGlone recently voiced this concern, saying “It may be logical for a revolutionary digital asset/currency that came of age during an unprecedented period of zero and negative interest rates to revert some when rates rise.”
Excessive concentration is never a good thing.
Kaiko, a crypto intelligence firm closely monitoring liquidity, has recently published a research detailing the trends in crypto trading volume and market depth concentration. While it takes into consideration all crypto markets, is representative of Bitcoin alone as well.
The study revealed that spot (i.e., not derivatives) trading volume has become more concentrated within the top exchange, which is Binance, bringing its market share from 38% in 2021 to a staggering 64% in 2023. Together with just 7 other exchanges (OKX, Coinbase, Upbit, Bybit, KuCoin, Huobi, and Kraken), it represents almost 90% of all crypto trading.
This situation has two facets. On one hand, it allows to offset liquidity shortage by concentrating 64% of the market’s orders on one exchange. On the other hand, it shows that this liquidity shortage existed indeed – it was the very reason that drove trading activity to one place where people could find the liquidity they needed. Binance’s zero-fee trading promotion helped it to become such place.
For the crypto markets overall, Binance’s outsized role represents a risk. If anything were to happen to it (failure, security breach, market manipulation…), the repercussions on the whole industry would be dramatic.
What about market depth?
In contrast, this metric has decreased for the top exchange. Since 2021, the variety of orders on Binance has fallen from 42% to under 31%.
HODLing Bitcoin once was considered the right thing to do, resisting to the pressure of price drops and long bear markets. However, it has shown its limitations quite fast.
Indeed, while not contributing to the price drops is rather beneficial for the market, taking BTC out of circulation is not.
According to Glassnode, an on-chain analytics firm, the total supply held by long-term holders (addresses that hold the coins for over 155 days) has now exceeded a staggering 14.5 million $BTC. This means that 75% of the total circulating supply of 19.4 million BTC is being hold long-term.
Here again, one can rejoice that true Bitcoin believers are firm in their commitment. However, this also means that the liquidity is progressively drying up.
We can still see the drops in long-term holder balances during price peaks (kudos to those who sold intelligently at the top), but the overall trend is definitely going up.
The divergence between short-term and long-term holders is continuously increasing: as the so-called “paper-hands” are taken over by panic and sell their coins as the price falls, the steadfast “diamond-hands” are always there to buy.
Let’s face it: HODLing is not good for Bitcoin. A currency must be used and circulating, not hoarded like a dragon’s treasure 🐉
This realization has given rise to a new paradigm for Bitcoin aficionados: Spend, then Replace. It means using BTC as a means of payment as often as possible and buying new BTC with dollars and euros, in which most of our salaries are still paid.
Such behavior – that some have already dubbed SPENDL – will create a healthy circulation and liquidity in the Bitcoin market.
Of course, it is crucial that the SPENDL attitude is adopted by the biggest whales, such as Microstrategy and Co, but we can all do our part in maintaining Bitcoin liquidity.
Now, you know what to do 😊