Detailed analysis of the reasons for the liquidity crunch in the currency circle

In the world of finance, long before cryptocurrencies existed, there was a popular saying about liquidity, “Liquidity is like oxygen. You don’t notice you need it until it’s not there.” In fact, When trades go smoothly, we never see any issues as liquidity levels remain stable. However, when operating in an illiquid market, a lack of liquidity at any level can be detrimental. Higher levels of liquidity are always preferred as it brings several advantages that basically highlight the importance of crypto liquidity. Many investors want to understand the reasons for the tight liquidity in the currency circle. Let the editor analyze it for everyone.

Causes of tight liquidity in the currency circle

Take the FTX exchange, which has recently attracted much attention due to liquidity pressure in the currency circle, as an example. It can be understood that Its acquisition by Binance. This liquidity squeeze may stem from uncertainty in the crypto market, causing investors to sell off assets. The “strategic transaction” reached by FTX and Binance has also attracted widespread attention, and due diligence is precisely to ensure that both parties can reach a lasting cooperative relationship. This kind of transaction also reflects that the cryptocurrency market is going through a stage of rapid change and integration.

Changpeng Zhao, co-founder and CEO of Binance, also said that FTX has liquidity problems. In order to safeguard the interests of users, Binance signed an unbinding letter of intent with FTX and plans to fully acquire FTX to solve this problem. It is reported that FTX’s liquidity dilemma is mainly due to the bankruptcy rumors of Alameda Research, a hedge fund owned by the founder.

On November 2, the cryptocurrency website CoinDesk published a balance sheet details of Alameda Research. The report shows that the company has total assets of US$14.6 billion and liabilities of approximately US$8 billion, including loans worth US$7.4 billion. Among the company's assets, FTT (FTX's native encryption token) is its largest single asset, holding approximately 140 million pieces. FTT-related assets are US$5.8 billion, accounting for 88% of its net assets.

The report emphasized that the company has more than US$5.8 billion in FTT on its books, but the circulating supply of FTT is only about US$4.36 billion. The news quickly sparked concerns in the crypto market about FTX’s liquidity, and the exchange immediately suffered massive withdrawals. FTT plunged more than 80% on Tuesday, as low as $4.3. According to CryptoQuant data, FTX’s stablecoin reserves fell to a yearly low on Monday as withdrawals increased, having declined by more than 90% in the past two weeks.

The Importance of Liquidity in the Currency Circle

Research shows that liquidity risk has a significant impact on cryptocurrency prices, even in the absence of speculative bubbles. Maintaining good liquidity is crucial for investors and traders to effectively reduce the impact of these risks. Extreme price fluctuations can be clearly demonstrated through the study of the bell curve, which reflects the probability distribution of expected price outcomes. Taking Bitcoin as an example, when its liquidity is low, price fluctuations will be more violent and unpredictable because it is further away from a normal distribution (with real-valued random variables). This situation makes Bitcoin price movements more uncertain and sudden.

For the non-geeks out there, a tall bell-shaped distribution with tall peaks, thin middle, and fat tail means one thing. On the one hand, there is the potential for huge returns. On the other hand, there are sudden losses. It is difficult to predict the exact time of an event, but it will happen 100% of the time.

This distribution also shows that dramatic boom-bust events generally do not have long-term destabilizing effects on markets. In fact, Bitcoin price history includes up or down swings of up to 40% in a day, which is 8 standard deviations from the mean. After such a correction, prices quickly stabilized. But in the short term, traders face significant risks if liquidity is poor during a rally. Good liquidity is the secret to reducing market risks such as BTC/USD, which has extremely high levels of financial risk. Good liquidity can improve market quality under the following circumstances.

I hope everyone can understand the reasons for the tight liquidity in this currency circle through the above article. Understanding the importance of cryptocurrency liquidity in the Middle East will undoubtedly help everyone make better investment decisions and further avoid investing at higher costs. In the traditional sense, liquidity is defined as the ability to easily convert assets into cash. In the crypto world, this refers to the ability to easily convert coins into cash or other coins. Illiquid markets are not advisable, so to avoid trading in such an environment, please pay close attention to bid-ask spreads and investigate market depth before trading. There are many more guides and articles on all cryptocurrencies, so stay tuned.

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