Cryptocurrency liquidity has long been a thorny issue for enthusiasts and evangelists. Although they eagerly promote the ecosystem and tout blockchain’s benefits, the elephant in the room that most enthusiasts willingly ignore is the challenging liquidity conditions that impact cryptocurrency markets’ orderly flow.
The enormous volatility witnessed across the cryptosphere has been a staple of the industry since Bitcoin trading began. Intraday moves exceeding 10% are not uncommon or unheard of, and even steeper inclines and declines have dotted the trading landscape fairly regularly over the years.
Still, the market itself has been slow to address the root cause, instead blaming the activities of malicious actors, whales or technical mistakes for sudden swings and substantial mispricings that regularly arise between exchanges.
Following a coordinated XRP selloff on the recently launched Beaxy Exchange, crypto advocates must once again come to the defense of an industry that has inadequately addressed security, manipulative behavior, and most importantly, poor liquidity. As the defense of its actions demonstrate, Beaxy Exchange eagerly blamed an exploit for its own mistaken implementation of the XRP parameters for transaction payment.
However, these mistakes are entirely preventable. For the ecosystem to attract capital and enjoy its advantages over traditional financial markets, accountability for liquidity, security and transparency must materialize.
Addressing the imbalances
Far from Satoshi Nakamoto’s vision of a decentralized environment for transferring data, centralized cryptocurrency exchanges have been controversial, to say the least. On one hand, they provide one of the simplest of on-ramps for joining the nascent industry and marketplace. But on the other, these on-ramps regularly expose users to numerous risks — including fraud, theft or lack of investor protections.
While the pace of global regulation is assuredly accelerating, it has not emerged as a stabilizing force for the cryptocurrency marketplace. Regardless, regulation is just one aspect of the imbalances cryptocurrencies face when compared to more established, traditional marketplaces like equity markets.
Unlike the Wild West mentality that pervades global cryptocurrency exchanges, stocks traded on United States exchanges have built-in safeguards designed to protect investors from irregular market behavior and to limit volatility. Apart from issuing trading halts for specific securities if they decline by more than a certain percentage within a defined period, there are market-wide halts — known as circuit breakers — if major benchmarks also experience sharp declines. This is but one measure designed to control overall market volatility, and others were designed to deliver similar benefits.
For instance, the “specialists” operating in the trading pits of the New York Stock Exchange act as market makers to add liquidity while maintaining an orderly flow of prices and trade execution. The reality for cryptocurrency markets is much different. Building advanced liquidity strategies is difficult in such a fragmented marketplace, wherein each exchange likely acts as its own principal market maker for a variety of different listed assets.
Without specialists in place or the advent of multiple liquidity providers to ensure exchange stability and organized processing of orders — especially during periods of high volatility — sharp increases in order flow can cause serious service outages that are reflected in price volatility and flash crashes. Nevertheless, poor liquidity is just one of the conditions needed to spark a sell-off that can crash the altcoin market.
Banishing bad behavior
Coordinated sell-offs like the one that transpired at Beaxy Exchange can simply be the outcome of the absence of proper protections. While some exchanges are fighting back against these types of situations by implementing better Know Your Customer practices and technologies designed to identify aberrant behavior akin to the Smarts Trade Surveillance system, they are more the exception than the rule.
Manipulative trade behaviors — such as wash trading, spoofing, and pump-and-dumps — continue to proliferate largely unabated. The efforts undertaken by many exchanges to inflate trading volumes to raise their CoinMarketCap ranking remains a problem of epidemic proportions.
These exploitative strategies do have very real consequences for altcoin traders that find themselves on the wrong side of the price action. Combining blatant manipulation with a low-liquidity environment creates the ideal conditions needed for high volatility and significant price crashes. What it will take to remedy the situation is an industry-wide effort aimed at course-correcting the on-ramp that allow these types of behaviors to flourish. OKex’s head of operations, Andy Cheug, spoke to Cointelegraph, revealing how his exchange combats such malicious activity:
“In both the traditional finance and crypto industries, the market is not immune the aberrant trading including wash trading, spoofing, coordinated selloffs, and it is a challenge that industrious people are continuously tackling. We deter these kinds of abrasive behaviors via different measures, namely our internal 24/7 trading surveillance system which is capable of identifying abnormal behaviors and consequently alerting our risk and compliance departments.”
Nevertheless, while some industry insiders pin the onus on internal controls designed to prevent these types of manipulations, others view the solution as a regulatory prerogative. However, in light of a lack of a transnational framework for addressing this challenge, the likelihood of regulation addressing coordinated sell-offs in the near term remains a distant hope. Branson Lee, the CEO of the Ecxx exchange, noted on the matter:
“Crypto exchanges are not regulated like typical security exchanges and this exposes market participants to all types of manipulation. We believe there should be rule books and exchanges should work hand in hand with regulators to be fully compliant. Currently, a lot of exchanges are benefiting from regulatory arbitrage, partly because regulations are just starting to catch up with blockchain.“
The path toward restoring credibility
While certain industry participants are increasingly moving in the direction of enhanced security and improved liquidity, much remains to be done to reinvigorate trust among altcoin traders. The conditions for sharp sell-offs in altcoins across less thorough exchanges remain omnipresent, and even their larger, most established peers face similar threats.
Although lauded for its capacity for decentralization, if cryptocurrency continues to open its doors to the uninitiated via centralized exchanges, more accountability must be a part of any industry-wide fix. This ultimately comes down to regulators forging a comprehensive approach to security, liquidity and trade surveillance, all for the benefit of real credibility that crypto users can actually count on to protect their interests.