The cryptocurrency market, despite its rapid growth, faces the issue of fragmented and weak liquidity.

Written by: Arthur Azizov, Founder of B2 Ventures

Translated by: Shan Ouba, Jinse Finance

Although the cryptocurrency industry is growing rapidly and idealizes decentralization, its liquidity remains fragmented and weak—reflecting the hidden risks of traditional finance and exposing the entire market to sudden shocks when market sentiment changes.

While cryptocurrencies possess decentralized characteristics and promise innovation, they ultimately remain a form of "currency." And all currencies cannot escape the reality of the current market structure.

As the cryptocurrency market develops, it increasingly resembles the evolutionary process of traditional financial instruments' lifecycles. The "illusion of liquidity" has become one of the most pressing yet least discussed issues, an inevitable byproduct of the market's maturation process.

In 2024, the total valuation of the global cryptocurrency market is estimated to be $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 significant vulnerability. Like the foreign exchange and bond markets, the cryptocurrency market now faces the so-called "phantom liquidity" problem: order books that appear liquid during stable market conditions can dry up instantly during extreme volatility.

The Illusion of Liquidity

The foreign exchange market has a daily trading volume exceeding $7.5 trillion and has historically been considered the most liquid market. However, even this market is beginning to show signs of fragility.

Some financial institutions and traders have started to be wary of the so-called illusion of market depth. Even in the most liquid currency pairs, such as EUR/USD, slippage occurs frequently. After the 2008 financial crisis, no bank or market maker was willing to take on the storage risk (i.e., the risk of holding volatile assets) during market sell-offs.

In 2018, Morgan Stanley pointed out the structural shift of liquidity risk: higher capital requirements post-financial crisis forced banks out of the liquidity provision space. The risk did not disappear; it merely shifted to asset managers, ETFs, and algorithmic trading systems.

Once upon a time, index funds and ETFs surged like mushrooms after rain. In 2007, index funds held only 4% of the MSCI World Free Float Index, but by 2018, this proportion had tripled to 12%, with some assets even reaching 25%. This created a structural mismatch—financial products that appeared liquid actually carried assets with very low liquidity.

ETFs and passive funds promise "freedom to enter and exit," but the assets they hold (especially corporate bonds) often fail to meet expectations during market volatility. In extreme fluctuations, ETFs are often sold off more aggressively than the underlying assets; market makers widen the bid-ask spread or even completely exit trading because they are unwilling to take on positions in chaos.

This phenomenon, which once occurred only in traditional finance, is now being "skillfully" replayed in the cryptocurrency market. On-chain activity, centralized exchange order books, and trading volumes may appear healthy, but when sentiment shifts, market depth often evaporates instantly.

The "Illusion of Liquidity" in the Cryptocurrency Market is Coming to Light

This illusion of liquidity in the cryptocurrency market is not a new phenomenon. During the market downturn in 2022, even mainstream tokens experienced significant slippage and widening spreads on top exchanges.

The recent crash of Mantra's OM token serves as another warning—when market sentiment shifts dramatically, buy orders can disappear in an instant, and price support evaporates. What once seemed like a deep market during calm periods can collapse rapidly under pressure.

The root of the problem lies in the fact that the market infrastructure for cryptocurrencies remains highly fragmented. Unlike the stock or foreign exchange markets, the liquidity of crypto assets is distributed across multiple exchanges, each with its own order book and market-making system.

For "second-tier" tokens ranked outside the top 20 by market capitalization, this fragmentation is particularly severe. They are often listed on multiple exchanges but lack a unified pricing mechanism or coordinated market maker support, relying more on task-oriented market participants. They may appear to have liquidity, but in reality, they lack genuine depth and coordination.

Worse still, some project teams and market participants create false liquidity to attract attention or secure listing opportunities. Practices such as wash trading, fake trading volumes, and order book manipulation are particularly common on smaller exchanges.

These "fraudsters" immediately withdraw when volatility strikes, leaving retail investors to face the risks of price crashes alone. Liquidity is not just "fragile"; at times, it is even "fabricated."

Solution: Unifying Liquidity at the Protocol Level

To truly address the issue of fragmented liquidity, deep integration must be achieved at the foundational protocol level. This means that cross-chain bridging and routing functions should be embedded within the core architecture of the blockchain, rather than being patched on afterward.

Currently, some Layer 1 blockchains have begun adopting this new architectural design, viewing asset circulation as a core mechanism of the blockchain itself. This approach helps unify liquidity pools, reduce fragmentation, and enable smoother capital flow across the entire market.

At the same time, the underlying infrastructure has seen significant improvements: orders that once required 200 milliseconds to execute now only take 10 to 20 milliseconds. Cloud ecosystems like 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: allowing market makers and trading bots to operate in real-time on a global scale. Notably, up to 70% to 90% of trading volume in stablecoins in the current cryptocurrency market comes from automated trading systems.

However, a high-performance "pipeline" system is just the foundation. More importantly, it must be paired with protocol-level smart interoperability and a unified liquidity routing mechanism; otherwise, it is like building a high-speed rail on fractured land—fast, but with no unified direction.

But now, all of this infrastructure is in place, sufficient to support the construction of a larger financial system.

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