Bitcoin Rally Faces Falling Market Liquidity

According to JPMorgan, Bitcoin's market liquidity is currently much lower than the market liquidity in gold or indices. Thus, it indicates that even smaller trades involving the cryptocurrency can have a significant price impact on it.

Image Source: © Prim91 | Megapixl.com

Indeed, Bitcoin is an inherently volatile asset. However, the lack of liquidity in the market makes it even more prone to deep price swings, which can affect the price of other cryptocurrencies as well. Read this article before you purchase bitcoin, to be aware of the benefits as well as the risks.

Fluctuating Price Tendencies

Experts believe that several factors helped to ignite BTC pricing in early 2021. The electric-car manufacturer Tesla recently acquired $1.5 billion worth of the digital asset, according to an SEC report.

Around the same period, Tesla's CEO Elon Musk utilised his Twitter account to post several supportive comments about Bitcoin, which helped to fuel the positive trend even more.

Once BTC went on full-bullish-mode, many companies started to look at it differently, especially as Tesla's acquisition helped to solidify its position among industry-leading players.

Following the frenzy, BTC prices raised once more as they were affected by a huge acquisition made by MicroStrategy, an important company specialized in business intelligence and technology. The company is said to have raised more than $1 billion of debt to fund more purchases of Bitcoin.

Market Movements Affect Bitcoin's Liquidity

Bitcoin was first introduced in 2009. However, the first currency quotations, that is, the first Bitcoin price information, are even more recent - only in July 2010, the exchange Mt. Gox (which went bankrupt after the famous hack event) showed the world the first Bitcoin quotations.

Due to its relatively new and unprecedented value offer, the volatility in Bitcoin's price fluctuation is relatively high, especially when compared to TradFi global currencies (e.g., US dollar).

Such volatility stems from several causes, including the small number of organised crypto markets around the world, regulatory issues, and uncertainties that prevent the industry from maturing more quickly. And obviously, there is a huge liquidity issue.

Liquidity can be measured in different ways. It is possible to measure the number of people and companies using Bitcoin, which allows the observer to have an idea of ​​the number of users of the currency.

The greater the facility to convert an asset into money, the greater its liquidity tends to be. Bitcoin's price quotation happens mainly in organised markets, especially cryptocurrency exchanges. Hence, investors compare Bitcoin trading volumes with those of the Forex market to have a reliable parameter of BTC's liquidity.

Miner Scarcity is Also Affecting Bitcoin's Liquidity

Another factor that could affect the circulating supply of Bitcoin in the short-term is miner scarcity.

© Thekaikoro | Megapixl.com

According to Kyle Davies, the co-founder of Three Arrows Capital, there is a shortage of ASIC  (Application Specific Integrated Circuit) miners. Miners generally distribute capital to buy hardware, like ASIC miners. But, given that they cannot buy, this could potentially lead to BTC inflows.

Unfortunately, there is a big shortage of ASICs - the devices designed for the sole purpose of mining cryptocurrency.

Miners just need to sell sufficient bitcoin to cover current US$ operational costs. Consequently, they are incentivized to hold all capital in BTC, that would otherwise be deployed into buying hardware.

The combination of several factors, such as the increased Hodling activity, the likelihood that miners will sell less BTC and the decrease in Bitcoin's liquidity could further fuel BTC's not-so-good momentum in the first quarter of 2021.

Bitcoin is Suffering Its Biggest Liquidity Depletion in Years

According to a tweet published by Glassnode on January 21, Bitcoin is experiencing the largest depletion of liquidity in years, which could also affect digital currency prices in general, as everything circles around BTC.

The fact is the last 30 days before this message was tweeted, around 270,000 Bitcoins were sent to entities considered "hodlers"- investors who keep their cryptocurrencies thinking about making a profit in the long run.

Currently, funds are not only being withdrawn from exchanges, but currencies are continually going into strong hands - which certainly includes several crypto whales - creating a negative market sentiment among investors.

As a result of the ever-growing scarcity, platforms like eToro announced a restriction on Bitcoin purchases on the weekends. According to them, the unprecedented demand for BTC, summed with limited liquidity, challenges its ability to support purchase orders over the weekend.

Final Thoughts

On February 22, Bitcoin reached its biggest weekly devaluation since September 2020, when the cryptocurrency had recorded a 12% loss, accompanied by the decrease in the asset's market liquidity.

According to industry-leading firms, Bitcoin's market liquidity is currently much lower than the market liquidity for other assets such as commodities and indexes. Consequently, even smaller trades involving BTC have a huge impact on its pricing.

Also, the massive amounts of BTC purchased as treasury reserve by companies like Tesla and MicroStrategy, as well as crypto whales and hodlers, deeply affect the cryptocurrency market towards a decrease in its liquidity.

Author Bio

Santa is a Latvia-based cryptocurrency journalist with a passion for covering the latest happenings in the cryptocurrency and tech world. In addition to being the analytics specialist of Paybis, Santa is also into consulting, reading, and investigative journalism.