The recent theory that a very small number of Bitcoin holders, possibly even just one, caused a price drop in Bitcoin brings up the very important issue of liquidity in crypto markets. For those that don’t know, liquidity has many meanings in the financial world, but in short it defines the ability of an asset to be traded efficiently. In this case when talking about markets, market liquidity/efficiency means that you can buy and sell the asset in the marketplace without causing wild price swings as well as it being easy to buy and sell those assets. This is why things like stock markets or currency markets are considered liquid. You can easily trade the assets and cash out and a majority of transactions don’t cause wild price swings.
The problem is that the current state of crypto markets are not very liquid at all since a majority of trading is in crypto pairs, not USD pairs. Crypto is not a very liquid asset so this sets up a liquidity issue by default. Because of this, we end up seeing a market where a very small amount of trading can have a huge impact on the price and the market cap. This situation also sets up a scenario that is ripe for manipulation.
So going back to the Mt. Gox issue, we have a small amount of Bitcoins totaling about $400 million which caused a significant price drop when the holder looked to cash out of a very illiquid market. This tells us the marketplace for Bitcoin is still very thin despite the market cap. It also brings into the question the market cap itself as an accurate indicator as well as the reported trade volume. The trade volume would appear to be mostly fake and made up of bots wash trading small amounts of BTC up and down all day so other bots can make quick trades profiting from the price action. This creates false trade volume and spoof orders on the books and makes the market appear more liquid and widely traded than it is.
But the real issue with all this being said is once again the Tether situation. Tethers make up a huge portion of the entire crypto market liquidity at this point. Liquidity that we now see as worse than the numbers would have us believe. As of this writing, Tethers are the second most traded asset on crypto markets with a share of 15%. Not only that, several times in the past week, the amount of Tethers traded exceeded the supply of Tethers themselves. This would suggest that all Tethers are changing hands on a daily basis which would only truly occur during a wild trading session and not a regular occurrence. The fact that it happens on a daily basis shows us that the trade volume is mostly wash trading and fake volume by bots. Bots wash trading exceeds all human trading in the crypto markets.
So if crypto markets already have a liquidity problem, and the liquidity it does have is mostly fake money (Tethers) being traded in small amounts by bots, what does that tell us? Well, it tells us that the overall crypto market is even more fragile than we think. We all accept that crypto is volatile, but the markets could be nothing more than a house built on sand. Not only that, if Tethers do turn out to be fake money or if a regulator shuts them down, the effect on the market will make Mt. Gox look like a blip on the charts. The markets could very well cease to even function at that point.
Now, am I calling for an apocalyptic collapse of the crypto markets in the coming days, no I’m not saying that. But the events of the last few weeks have shown us that the markets are far more fragile and far more illiquid than most of us previously thought.