08 September 2021

Market commentary:The grand liquidity evaporation

Patrick Heusser

Patrick Heusser

Head of Trading bei Crypto Finance (Brokerage) AG

Über den Autor

During days like yesterday I hardly have time to pick up any DMs or give a proper answer to questions coming in. Obviously, everyone wanted to know: „What the hell is happening!?!“

Firstly, I would like to look at leverage. Some accounts I follow on Twitter were pointing to the large amount of liquidations which they believe has caused the crash. I see it slightly differently. The amount of leverage in the system was moderate. As I pointed out in my TA-Tuesday, we were far away form the „overheated“ state that we were in just before the ATH in April/May. Also, following that period most of the larger exchanges reduced their leverage offering significantly. The only ruthless exchange is ByBit where you still can take on up to 100x leverage.

My take is that we are still seeing liquidity evaporation on the back of different factors:

– USD banking holiday

– Bullish price action during the long weekend (US banking holiday) – this extends the short USD situation in the system

– Trading venues and exchanges were not able to cope with the flow (details below)

– Clogged up blockchains and high fees (especially Ethereum)

We did mention last week that long weekends could stir some volatility especially when there is a US holiday involved. The call was right, but only the timing was a little bit off. Let me explain how the above issues can be a deadly mix for liquidity.

I am sure, market makers and liquidity providers did plan for the long weekend and deployed capital across their trading venues. They might have been a little bit surprised by the strong upward price action during the weekend but were happy to hedge most of the futures volume with physical spot trades (nice basis). The consequence of this was that most of the market makers and liquidity providers were running low on USD or stable coins. Since Monday was a pretty quiet day nobody was rushing aggressively to move USD back onto their trading venues.

Now, the sell-off started and we already experienced some issues with certain venues showing wider spreads and less liquidity in the order books (driven by the risk management systems of the market makers). Additionally, one venue after the other started to go down, offline or in maintenance (see list below):

Coinbase: 404 on order entry and latent market data

Gemini: lagged on market data and then shut down

Kraken: order entry failed – UI was overloaded (but didn’t officially go down)

Binance US: fully broken – just did not work

Bitfinex: went into maintenance during the crash

CME: brokers refused to execute orders due to delayed reaction to limit down trigger

FTX US: had some aggressive rate limiting on users but worked

In an instant market makers and liquidity providers saw their trading universe shrink to a few venues and – do not forget – this all happened when volume had increased roughly 10x compared to normal market hours. As a consequence, they lowered their quoted amounts significantly and widened the spreads. But what gave them the biggest headache was the reshuffling of liquidity/collateral. With clogged up blockchains and very high GAS costs on Ethereum made the whole liquidity issue worse and some of the market makers and liquidity providers started to shut down.

This is when the market dropped to the lows we experienced and we saw massive price divergences between different trading venues. We felt the heat on our trading desk as well. At the peak hour we had almost 1’000 trades per hour and we were market making on exchanges, executing agency orders, and providing streaming prices of 51 different pairs for clients who traded with us on a principal basis.

For the newcomers… Welcome to crypto and happy trading!