Bitcoin was a winner during the US banking crisis, but illiquidity prevents it from being a USD hedge

If there was a bitcoin marketing team, the last month would be as good as it gets for them.

Trust in banks in the US and Europe has been decimated and people are looking for an alternative to protect their dollars. Enter Bitcoin (BTC), an asset created solely for this purpose – a truly decentralized form of money that cannot be controlled by any entity.

Conor Ryder is a research analyst at crypto data firm Kaiko.

At first glance, the recent banking crisis appears to be the perfect catalyst for a BTC price rally. However, if we delve a little deeper into the reasons for the move, we point in the direction of liquidity and specifically the lack of liquidity.

While the narrative makes sense and has led to many people looking for Bitcoin at exactly the same time, illiquidity has almost certainly been a strong price driver.

I’m going to take a moment here to congratulate the BTC Maxis. They haven’t had much to celebrate lately. But this is the moment Bitcoin was created for, and it is the first time since its inception that there has been a crisis of confidence in the banking system.

For the first time since 2008, people have started to realize that the US dollars (USD) they hold are at greater than expected risk, making BTC appear quite attractive as a percentage of a broader portfolio.

But while these types of narratives designed to explain or predict price movements are powerful, the current market structure cannot be ignored.

When liquidity in a financial market is low, volatility in both directions is high. Prices have less support both on the downside and on the upside. In this case, the narrative of Bitcoin as a hedge against financial disasters gave BTC the boost it needed. But there was little upside resistance to overcome: BTC market depth, the number of orders waiting to be filled in an order book, hit a 10-month low this week — lower than levels since Collapse of the FTX exchange and its sister company Alameda Research.

The post-FTX dip is something we call the “Alameda Gap,” which explains how the crypto market’s liquidity has evaporated in the absence of one of the biggest digital asset market makers. This liquidity gap has not recovered and continues to set new lows following the Silvergate and Signature banking crises that cut market makers off of key USD payment lanes. When market makers are faced with this type of unprecedented operational challenge, their response is to pull liquidity from order books until they get some clarity.

Another word of warning is the reintroduction of fees on Binance’s BTC-USDT and BTC-BUSD trading pairs. We have seen a sharp drop in liquidity on these pairs over the past few days as fees have been reinstated. A fee means that market makers on these pairs can no longer justify their wide spreads (the difference in price between the bid and ask prices), which means they have to offer tighter spreads, affecting their profitability.

As a result, the liquidity of the BTC-USDT pair on Binance, the most liquid pair in crypto, plummeted 70% overnight. The only fee-free pair is now BTC-TUSD. If liquidity does not flow into this pair, the order books could be further depleted in the coming weeks.

All of this means that it now takes less and less “size” to move the price of BTC, potentially leading to volatility as more traders are able to influence prices. Luckily for investors, the crisis in bank confidence led to an increase in buying pressure, which has been driving the price higher so far.

However, the lack of support on the upside also applies to the downside, meaning we must be just as cautious of any outsized move lower in the coming weeks. All this to say that it is too early for a Bitcoin Maxi winning streak.

While the rotation of capital into BTC certainly makes sense given everything we’ve seen in traditional markets over the past two weeks, illiquidity arguably played the biggest role in crypto’s surge.

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