Author: Arthur Azizov, founder of B2 Ventures Source: cointelegraph Translation: Shan Ouba, Golden Finance
Despite the rapid growth of the crypto industry and its ideal of decentralization, its liquidity remains fragmented and fragile - reflecting the hidden risks of traditional finance and exposing the entire market to sudden shocks when market sentiment changes.
Although cryptocurrency has decentralized characteristics and promises to bring innovation, it is still a "currency" in the final analysis. And all currencies cannot escape the reality of the current market structure.
As the crypto market develops, it increasingly resembles the life cycle evolution of traditional financial instruments. **"The illusion of liquidity"** has become one of the most urgent but least discussed issues, which is an inevitable byproduct of the entire market maturation process.
In 2024, the global cryptocurrency market was valued at $2.49 trillion, and is expected to double to $5.73 trillion by 2033, with a compound annual growth rate of 9.7% over the next decade.
However, beneath this strong growth lies a huge vulnerability. Just like the foreign exchange and bond markets, the crypto market now faces the so-called "phantom liquidity" problem: order books that appear to be liquid when the market is stable suddenly dry up during violent fluctuations.
The illusion of liquidity
With a daily trading volume of more than $7.5 trillion, the foreign exchange market has historically been considered the most liquid market. However, even this market is now beginning to show fragility.
Some financial institutions and traders are beginning to be wary of the so-called illusion of market depth. Slippage is also frequent on the most liquid currency pairs, such as the euro/dollar (EUR/USD). After the 2008 financial crisis, no bank or market maker was willing to take on warehousing risk (the risk of holding volatile assets) during a market sell-off.
In 2018, Morgan Stanley pointed out the structural shift in liquidity risk: higher capital requirements after the financial crisis forced banks to exit the liquidity provision field. The risk did not disappear, but was transferred to asset managers, ETFs and algorithmic trading systems.
Once upon a time, index funds and ETFs sprang up like mushrooms after rain. In 2007, index funds held only 4% of MSCI World Free Float, but by 2018, this proportion had tripled to 12%, and some targets even reached 25%. This created a structural mismatch - financial products that look liquid, but actually carry assets with extremely low liquidity.
ETFs and passive funds promise "free entry and exit", but the assets they hold (especially corporate bonds) often fail to deliver on expectations when the market fluctuates violently. During violent fluctuations, ETFs are often sold off more violently than the underlying assets; market makers will widen the bid-ask spread or even exit the transaction completely because they are unwilling to take over in the chaos.
This phenomenon, which originally only occurred in traditional finance, is now "expertly" repeating in the crypto market. On-chain activity, centralized exchange order books and trading volumes may look healthy, but when sentiment changes, market depth often evaporates in an instant.
The "liquidity illusion" in the crypto market is surfacing
This liquidity illusion in the crypto market is not new. During the market downturn in 2022, even mainstream tokens experienced significant slippage and widening spreads on top exchanges.
The recent plunge in Mantra’s OM token is another warning that when market sentiment changes dramatically, buying can disappear in an instant, and price support evaporates. Markets that seem deep in calm times can quickly collapse under pressure.
The root of the problem is that crypto’s market infrastructure remains highly fragmented. Unlike stocks or foreign exchange markets, liquidity for crypto assets is spread across multiple exchanges, each with its own order book and market-making system.
This fragmentation is particularly severe for “second-tier” tokens outside the top 20 by market capitalization. They are often listed on multiple exchanges, but without a unified pricing mechanism or unified market maker support, they rely more on a few task-oriented market participants. They appear to have liquidity, but lack real depth and coordination.
To make matters worse, some project owners and market participants will deliberately create fake liquidity in order to attract attention or obtain listing opportunities. Fake orders, fake trading volume, and order fraud are particularly common in small and medium-sized exchanges.
These "fake traders" immediately withdraw when they encounter volatility, leaving retail investors alone to face the risk of price crashes.
The solution: unify liquidity from the protocol layer
To truly solve the problem of liquidity fragmentation, deep integration must be achieved at the basic protocol layer. This means: Cross-chain bridging and routing functions should be embedded in the core architecture of the blockchain, rather than being patched after the fact.
Currently, some Layer 1 blockchains have begun to adopt this new architectural design, treating asset circulation as the core mechanism of the blockchain itself. This approach helps to unify liquidity pools, reduce fragmentation, and achieve smoother capital flow across the market.
At the same time, the underlying infrastructure has also been greatly improved: orders that once took 200 milliseconds to execute now only take 10-20 milliseconds. Cloud ecosystems such as Amazon and Google have supported full-chain transaction processing through P2P messaging mechanisms between clusters.
This performance layer is no longer a limitation, but an accelerator: it enables market makers and trading robots to operate in real time around the world. It is worth noting that currently up to 70%-90% of stablecoin trading volume in the crypto market comes from automated trading systems.
However, a high-performance "water pipe" system is only the foundation. What is more important is to cooperate with intelligent interoperability at the protocol level and a unified liquidity routing mechanism, otherwise it is like building a high-speed railway on fragmented land - running fast, but in different directions.
But now, all of this infrastructure is already in place, enough to support the establishment of a larger financial system.
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