Are decentralized exchanges the answer to crypto exchange liquidity problems?

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Ethereum, Flipcoin and Bitcoin Cryptocurrency coins

Cryptocurrencies have taken the world by storm and rattled the financial sector in many ways. Advocates of cryptocurrencies have long aimed to break away from the shackles of conventional financial systems. The calls for secured and a decentralized modes of transaction grew stronger, especially after 2010. Thus, the stage was set for cryptocurrencies to rise and shine and create ripples in the financial sector. Have cryptocurrencies managed to do that? 

The answer is yes and no. Why you may ask? Simply put, the market cap of the crypto market was around $137 billion, rising to a whopping $3 trillion at its peak in November 2021 [1]. However, the journey so far has been nothing short of a rollercoaster ride, and we do not expect things to change anytime soon. 

While the crypto ecosystem continues to expand, there is a lot of groundwork that needs to be done. For instance, the highly volatile crypto market coupled with huge price differences across different platforms. Crypto exchange liquidity problems continue to remain a major concern and it is the need of the hour to find solutions to address them. 

In this blog, we will examine the current crypto exchange liquidity problems and what is being done to address them. 

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Crypto market is more volatile than ever before – what can we expect?

An application on a digital device tracking crypto prices

In November 2021, the crypto market was at the apex in terms of market capitalization. It was impossible to foresee what was about to happen next. Bitcoin has seen its value shrink by more than 50% since November last year. Since then, the global crypto market has found it extremely difficult to recover. It is not just Bitcoin that is seeing bad days. Some cryptocurrencies are doing way worse. 

TerraUSD (UST) and Terra have seen their value plummet by huge margins, upsetting several investors. Investor confidence in crypto also took a huge blow when Sam Bankman-Fred’s FTX exchange collapsed recently. 

According to estimates from TradingView, the market capitalization of all digital assets has dipped below $800 billion, a level not seen since the beginning of 2021The market cap of the entire digital assets sector reduced by $183 billion as a result of the most recent volatility wave in the digital asset markets. On November 9, the amount fell to $736 billion, the lowest since January 2021.

The fall coincided with a new downward spiral in bitcoin and other cryptocurrency values caused by the FTX crisis. Bitcoin (BTC), the largest cryptocurrency, experienced its worst weekly performance in five months during the seven days ending on November 13.

These stories are enough evidence to prove the existing volatility in the crypto market. What can be done to address this issue? Will this continue? Let’s find out. 

What is crypto exchange liquidity?

The degree to which a market supports the sale and purchase of assets at predictable prices is referred to as liquidity. While higher liquidity tends to create a less volatile market and few price fluctuations, lower liquidity generally results in a more volatile market (especially when large orders are issued).

At present, cash is considered to be the most liquid asset. It means that the market will easily absorb a million-dollar transaction without affecting the value of the dollar. In addition, the costs involved with the transaction and the value of the currency during the transactions are known beforehand. 

If the same transaction were to be carried out with Bitcoin or any other cryptocurrency, it would have had a huge influence on the value of the cryptocurrency. This is spurred primarily by a lack of market liquidity. A specific trading platform may run out of Bitcoin, compelling buyers to spend 1–10% more than anticipated to complete a transaction. This could ultimately cost between $10,000 and $100,000 more than the initial trade price to complete the same $1 million transaction.

This is the crypto exchange liquidity problem and we need to find answers to address this issue. 

Time for decentralized platforms to shine

We have heard and read so many stories stating how the crypto sector is decentralized. Do you really believe that? Is it real or just a myth? According to Gary Gensler, the Chairman of the Securities and Exchange Commission (SEC), the crypto sector is far from being decentralized. Ironic right? 

He further said that one can see a monopoly in which only a few “intermediaries” are running the show and thwarting competition. Gensler said that the crypto market, which is fundamentally founded on the idea of decentralization is showing traits observed in a centralized market. 

Apart from this, there are other crypto exchange problems that do not work in favour of centralized platforms. Most centralized crypto exchanges are unable to handle the colossal surge of users, leading to system failures – an open invitation for hackers. Although many centralized exchanges have heavily invested in improving security, security breaches still exist. For example, when Bitfinex was hacked in 2021, thousands of users lost their savings. 

Decentralized trading platforms have strongly put their case forward and emerged as an alternative. In fact, they could potentially provide added value in the long run. Such platforms do external services to manage client funds. The overall experience while making peer-to-peer transactions is better since the entire process is automated. 

Users can also sit back and relax since their funds are secured in a personal wallet, instead of a third-party application. Decentralized platforms offer more privacy and have a lower risk of server downtime compared to centralized platforms. Therefore, we are likely to see significant growth in the uptake of decentralized crypto platforms in the future. 

Crypto liquidity solutions – can we address crypto exchange liquidity problems?

Moving forward, we need to concentrate efforts to enhance liquidity across decentralised trading platforms to increase adoption. We can only achieve this by finding crypto liquidity solutions that are future-proof.  Of course, a range of factors impacts an asset’s liquidity. It’s however not hard to imagine that demand for these assets might rise if the processes by which people deal with cryptocurrencies were simplified.

Without a single, more solid asset arising to control their value, there is little question that trading cryptocurrencies will continue to take place on various types of exchanges for the foreseeable future. As a result, it is imperative to find out-of-the-box solutions to solve market fragmentation and liquidity problems. 

One way to address the various crypto exchange problems is to reduce the cost involved while switching to other platforms for cryptocurrency traders. Users can access their wallets and carry out a token conversion without ever leaving them if an on-chain platform can access numerous reserves and lower the barriers around switching from one exchange to another. This can be executed to perfection by collaborating with other wallet providers. These are just a few crypto liquidity solutions that could provide answers to solve the existing issues. 

Crypto exchange liquidity is a major crypto exchange problem due to which, we could see the pendulum swing toward decentralized platforms shortly. Besides, liquidity is also one of the factors that could define the course of the overall crypto market. The public’s perception of cryptocurrencies as a valuable, safe, and secure method of currency exchange will only improve when we find solutions to overcome crypto exchange liquidity within the blockchain ecosystem, particularly in decentralized exchanges.

Yes, crypto exchange liquidity is an issue, luckily there are solutions to fix it

Bitcoin and Ethereum coins placed before a crypto market on a screen

By now we hope you have some understanding of one of the key crypto exchange problems – crypto exchange liquidity. While the problem exists, there are solutions to tackle this problem. 

Apart from a few solutions mentioned in the previous section, there are other ways to overcome this challenge. First, the monopoly has to end soon, and more players need to enter the decentralized crypto ecosystem. Second, users should have access to liquidity pools. Third, the adoption of stablecoins should increase as it allows traders to minimize the impact of volatility on their trades and make it easier to buy and sell cryptocurrencies. 

Lastly, when the adoption of cryptocurrencies will grow, the liquidity of the market should also improve. This can be achieved by educating the public about the benefits of cryptocurrencies and encouraging businesses to accept them as a form of payment. That said, we are still far away from reaching that stage, but things are steadily heading in that direction. We hope we soon find solutions to address all the minor and major crypto exchange problems.  

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Feature Image Source: Photo by Traxer on Unsplash

Image 1 Source: Photo by Viktor Forgacs on Unsplash

Image 2 Source: Photo by Pierre Borthiry – Peiobty on Unsplash

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Karandeep is a technical content writer based out of Pune, a city in India that is also known as the Oxford of the East. His journey with writing started in 2014 when he decided to try his luck in a gaming startup as a Content Developer. Since then, he has written on a wide range of topics within the gaming and the tech space. Apart from his love for gaming, Karandeep is keeping tabs on the hottest trends in the tech industry. After completing his Bachelors in Business Administration (BBA) from Symbiosis International University, Pune, he worked as an intern in an NGO that focused on urban development.
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