Written by: Arthur Azizov, Founder of B2 Ventures
Translated by: Shan Ouba, Jinse Finance
Despite the rapid growth of the crypto industry and its decentralization ideal, its liquidity remains scattered and fragile - reflecting hidden risks in traditional finance and exposing the entire market to sudden shocks when market sentiment changes.
Although cryptocurrencies have decentralized characteristics and promise innovation, they are ultimately still a "currency". 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 yet least discussed issues, an inevitable byproduct of the market's maturation process.
In 2024, the global cryptocurrency market's total valuation is $2.49 trillion, 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 enormous fragility. Like foreign exchange and bond markets, the crypto market now faces the so-called "ghost liquidity" problem: order books that appear liquid during stable markets instantly dry up during intense volatility.
The Illusion of Liquidity
The foreign exchange market, with daily trading volumes exceeding $7.5 trillion, has long been considered the most liquid market. However, even this market is now beginning to show vulnerability.
Some financial institutions and traders are becoming wary of the so-called market depth illusion. Even on the most liquid currency pairs like EUR/USD, slippage is frequent. After the 2008 financial crisis, no bank or market maker was willing to bear warehousing risk during market sell-offs.
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 hasn't disappeared; it has merely shifted to asset managers, ETFs, and algorithmic trading systems.
Index funds and ETFs have risen like mushrooms after rain. In 2007, index funds held only 4% of MSCI World free-float shares, but by 2018, this proportion had tripled to 12%, with some targets reaching as high as 25%. This created a structural mismatch - financial products that seem liquid but actually carry extremely low-liquidity assets.
ETFs and passive funds promise "free entry and exit", but the assets they hold (especially corporate bonds) often fail to meet expectations during market volatility. During intense fluctuations, ETFs are often sold more aggressively than underlying assets; market makers widen bid-ask spreads or even completely exit trading, as they are unwilling to take over during chaos.
This phenomenon, originally occurring only in traditional finance, is now being "skillfully" replayed in the crypto market. On-chain activity, centralized exchange order books, and trading volumes may seem healthy, but market depth can instantly evaporate when sentiment changes.
The "Liquidity Illusion" in the Crypto Market Emerges
This liquidity illusion in the crypto market is not new. During the market downturn in 2022, even mainstream tokens experienced significant slippage and spread expansion on top exchanges.
The recent sharp drop of Mantra's OM token is another warning - when market sentiment dramatically shifts, buy orders can instantly disappear, and price support evaporates. Markets that seem deep during calm periods can quickly collapse under pressure.
The root cause is that crypto market infrastructure remains highly fragmented. Unlike stock or forex markets, crypto asset liquidity is distributed across multiple exchanges, each with its own order book and market-making system.
This fragmentation is especially severe for "second-tier" tokens ranked outside the top 20. They are typically listed on multiple exchanges but lack a unified pricing mechanism or unified market maker support, relying more on task-oriented market participants. They appear liquid but lack real depth and coordination.
Worse, some project teams and market participants deliberately create false liquidity to attract attention or gain listing opportunities. Wash trading, fake trading volumes, and order baiting are especially common on small and medium exchanges.
These "forgers" immediately withdraw when volatility occurs, leaving retail investors to face the risk of price crashes alone. Liquidity is not just "fragile" but sometimes even "fabricated".
Solution: Unifying Liquidity at the Protocol Layer
To truly solve the liquidity fragmentation problem, deep integration must be achieved at the base protocol layer. This means cross-chain bridging and routing functions should be embedded in the blockchain's core architecture, not as an afterthought.
Currently, some Layer 1 blockchains are beginning to adopt this new architectural design, treating asset flow as a core mechanism of the blockchain itself. This approach helps unify liquidity pools, reduce fragmentation, and achieve smoother capital circulation across the entire market.
Meanwhile, underlying infrastructure has seen massive improvements: orders that previously required 200 milliseconds can now be executed in just 10-20 milliseconds. Cloud ecosystems like Amazon and Google, through P2P messaging mechanisms between clusters, now support transaction processing across the entire chain.
This performance layer is no longer a limitation but an accelerator: enabling market makers and trading bots to operate in real-time globally. Notably, 70-90% of stablecoin trading volume in the current crypto market comes from automated trading systems.
However, a high-performance "pipeline" system is just the foundation. More importantly, it must be combined with protocol-level smart interoperability and unified liquidity routing mechanisms; otherwise, it's like building a high-speed train on fragmented land - fast, but without a consistent direction.
But now, the entire infrastructure is in place, sufficient to support the construction of a larger financial system.
