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How can Probinex fix the liquidity conundrum?

The issue of liquidity comes up time and time again. We wrote this article to make it a bit clearer for you.

One of the greatest issues that plague many a developing cryptocurrency market is low liquidity. In this text, we’ll take a look at what liquidity is, what’s it got to do with trading volume, and how its lack affects cryptocurrency prices. We’ll also devote some time to the underlying causes and the opportunities we can take.

Liquidity and volatility — key concepts in traditional and emerging markets.

Liquidity is essentially the lifeblood of markets. It describes how easy it is to exchange a given asset for money — in other words, what demand there is for it — without causing a price spike. For example, government-issued fiat or shares have enormous liquidity, which allows companies to buy billions of dollars’ worth of them without noticeable impact on their price.

In contrast, cryptocurrencies, collectibles, or art typically have low supply and thus also low liquidity. A person buying a Pokémon card for 500 USD has no guarantee they’ll be able to sell it for the same price next week. It might be worth just 400 USD. The missing 100 USD are what we in the business call a “market cost”.

Cryptocurrencies aim to be viable currencies, but are, in fact, in many ways similar to collectibles. There are tens of thousands of crypto-projects, the consequence being a fragmentation of demand. Cryptocurrencies, including the largest ones, vie for every single user, leading to low liquidity and an environment where purchases in “mere” (from a traditional market’s viewpoint) millions of dollars can incur a spike of unbelievable 40% leading to a significant cost, with each dollar being worth fewer tokens than the last one. Same with selling. Higher volume transactions lead to each token being worth less and less (in dollars).

Trading volume, low liquidity and their effects on cryptocurrencies

Trading volume is closely related to liquidity. It is the amount of money and assets “flowing” through the market over a certain period. 24 hours, usually. It is generally expressed in US dollars, in the cryptocurrency market by stable cryptocurrencies such as USD Coin or Tether. These are pegged to the dollar at a 1:1 ratio. If trading volume goes up, so does liquidity and vice versa. That’s why these two variables are so important and why national banks, for example, pay very close attention to ensuring liquidity for their currencies, to protect citizens of their country.

Market costs associated with large transactions

If a market doesn’t have enough liquidity, a sufficiently large transaction can throw it off balance and the price post-transaction won’t reflect the “real worth” of the traded asset. See a chart below.

The moment of the large transaction is represented by a single red candle. It was closely followed by a correction, however, anyone buying before the correction lost money by buying underpriced asset.

Risky high volatility

Low liquidity naturally leads to high volatility. Essentially, volatility shows how “spiky” a price graph gets. See below.

At first glance, high volatility seems amazing. So many opportunities to get rich! But any professional would tell you it’s the opposite. High volatility makes the market a gamble, making it much easier to lose money as emotions run high. Greg could tell you about it.

“I wish I had kept my 1700 BTC I bought at $0.06 instead of selling it at $0.3. Now bitcoin is $8!”

Today, he would be a billionaire. Liquidity is a problem that more or less all cryptocurrency projects face.

Low liquidity in futures

The situation on the perpetual futures market is specific and by far the worst, especially when it comes to altcoins. Countless people have paid the price for its volatility.

Perpetual contracts are effectively a bet on whether the price of a cryptocurrency will go up or down. You don’t own any, you only have a contract entitling you for a payout from the exchange if your bet was correct. “Leverage” is another factor. It’s basically a loan, and various platforms offer up to 100x the trader’s investment. That means if you have 100 USD, the exchange will provide you with up to 9900 more.

Now imagine the following scenario. A single candle on a chart represents one minute.

Notice no correction followed the first drop, instead, starting an avalanche. This phenomenon is called a “long squeeze”. After the first transaction in an illiquid market, a chain liquidation occurs because the exchange forcibly sells off your cryptocurrencies to pay off the debt incurred by using leverage. With 100X leverage, a price drop of less than 1% is enough to liquidate!

The phenomenon is common in the cryptocurrency market due to reduced liquidity. In April 2021, when the price of BTC plunged 12%, traders lost over $13 billion in liquidations seized by the exchanges.

Causes of and opportunities presented by low liquidity

Low liquidity can occur for many reasons, often when the market enters depression and trading volume decreases. In the cryptocurrency market some common reasons are:

  • Lack of investment from financial institutions
  • Young and inexperienced industry. Cryptocurrencies are barely 13 years old, low liquidity is typical for projects that have yet to establish themselves.
  • A huge number of projects. Imagine a 10×10 pool 2 meters deep. How deep would it be if it suddenly expanded to 1000x1000?

Probinex intends to solve this problem once and for all. It will do so by combining the spot (normal) and futures markets. The merger will bring liquidity together into one efficient market.

Any solution must be based on thorough legal analysis. The market needs to be safe and regulated, for the sake of both individuals and institutions. Merging the principles of traditional and digital markets is not especially difficult from a technical standpoint. There are legal hurdles though. We at Probinex see this as an opportunity. Since the very beginning of our project we’ve sought various licenses to prepare for the regulated world.

Want to know more?

Are you interested in other issues cryptocurrencies face and Probinex aims to solve? Or maybe you just want to join a great community and discuss crypto? Whatever your goal, join our Telegram and you can reach our CEO Adam, CMO Michal and other team members any time of day.

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