Can Bitcoin and Ethereum ETFs Really Revolutionize the Cryptocurrency Market? Think Again…

The challenge of liquidity in the cryptocurrency market continues to be a significant issue. The recent introduction of exchange-traded funds (ETFs) for Bitcoin (BTC) and Ethereum (ETH) in the United States had sparked optimism for improvement. However, as per the latest report from Kaiko, these hopes have only been partially realized. Despite an uptick in trading volumes on major platforms since November 2022, the market still remains delicate and susceptible to sudden fluctuations. The report sheds light on two key aspects: the limited impact of ETFs on actual market liquidity and underlying structural issues.

The limited influence of ETFs on crypto market liquidity is underscored in Kaiko’s report released on August 29, 2024. The introduction of ETFs for Bitcoin and Ethereum was anticipated to enhance liquidity in the crypto markets. Following the FTX collapse in November 2022, there was a 30% surge in daily trading volume on the top ten crypto exchange platforms. However, this surge does not necessarily equate to adequate liquidity to accommodate large orders. The report emphasizes that trading volume, while a useful metric, is not a definitive measure of liquidity and can be inflated by activities such as wash trading or trading platform incentives.

Kaiko emphasizes the significance of “market depth,” which gauges a market’s ability to absorb substantial orders without causing significant price shifts. The volume/market depth ratio is proposed as a more dependable indicator to evaluate true liquidity. Despite the increased trading volume, the crypto market is not fully prepared to withstand major impacts, as evidenced by the significant market drop on August 2 following an unexpected rate hike by the Bank of Japan. This event led to notable “slippage” on Bitcoin orders, with trading pairs like BTC-EUR on KuCoin experiencing slippage exceeding 5%.

Moreover, beyond the constrained impact of ETFs, Kaiko’s report highlights additional challenges. A critical concern is the presence of “supply overhang,” denoting the existence of substantial crypto holdings that could be liquidated in the market. For instance, the legacy of Mt. Gox, with its 46,000 BTC awaiting redistribution, poses a persistent threat. Each distribution triggers a new wave of selling, contributing to further market disruptions. Additionally, several governments, including those of the United States, China, and Ukraine, hold significant amounts of Bitcoin that could be sold at any time, amplifying volatility risks.

These potential sell-offs, coupled with existing liquidity constraints, heighten the risks of significant slippage and unforeseen price fluctuations. Kaiko’s report points out that these market dynamics complicate risk assessment and management for investors, even seasoned ones. Furthermore, the fluctuation in liquidity levels throughout the day, with distinct periods of low liquidity, indicates a lack of resilience in the current market framework.

In conclusion, while the introduction of ETFs for Bitcoin and Ethereum has brought some liquidity improvements, challenges, particularly liquidity tightening, persist in the crypto market. With risks associated with “supply overhangs” and the fragility of market depth, the sector remains susceptible to market shocks.