Liquidity Crisis: Why Liquidity Shortage Becomes the Biggest Obstacle in the Crypto Market

What is liquidity actually? This question is becoming increasingly important in the crypto industry. According to Jason Atkins, Chief Commercial Officer at Auros (a leading crypto market maker), the fundamental issue in the crypto market is not volatility, but the worsening lack of liquidity. The shortage of liquidity has created structural barriers preventing large financial institutions from entering the market at scale, even though their interest remains very strong.

What Is Liquidity and Why Is It Important for Crypto

Liquidity refers to the market’s ability to absorb large trading volumes without experiencing significant price changes. In the context of crypto, liquidity is not just about how much money is circulating in the market, but about how easily traders and investors can buy or sell assets in large quantities quickly and at reasonable prices.

“You can’t just say institutional capital wants to enter if you don’t have channels for them to do so,” Atkins said. The current problem in the crypto market is that even when there is interest from large institutions to invest, the market infrastructure is not yet mature enough to handle such capital flows without destabilizing prices.

Structural Issue: The Reinforcing Cycle of Liquidity and Volatility

The lack of liquidity in the crypto market is not due to a loss of interest, but results from a series of major deleveraging events that have pushed leverage and traders out of the system much faster than they have returned. The October 10th crash is a perfect example of how market pressure can dramatically reduce order book depth.

The subsequent mechanisms create a reinforcing cycle: liquidity providers respond to demand rather than creating it. When trading activity declines, market makers naturally reduce their risk by narrowing bid-ask spreads and decreasing position sizes. This reduction in market depth then triggers higher volatility, which in turn leads to tighter risk controls and further withdrawal of liquidity. The result is a vicious cycle where illiquidity, volatility, and caution reinforce each other, keeping the market fragile despite long-term interest remaining intact.

Institutional Barriers: Challenges of Capital Conservation in Thin Markets

Volatility itself is not the main obstacle for institutional allocation. Problems arise when volatility clashes with thin markets that lack sufficient liquidity to protect large positions.

“Exploiting volatility is very difficult in illiquid markets,” Atkins said, “because positions become hard to hedge and even harder to exit.” This dynamic is far more critical for institutional allocators than for retail traders.

Large institutional investors operate under strict capital preservation mandates. They do not focus on maximizing absolute returns, but on maximizing relative returns while preserving capital. Structurally, institutions are unable to act as stabilizers when markets remain thin, so there is no natural buffer when selling pressure occurs.

Deleveraging and Its Impact on Market Depth

Deleveraging events cause long-term damage to the structure of crypto market liquidity. When leverage is forced out of the system, healthy trading volume does not immediately return. Instead, liquidity providers remain cautious, waiting for clear evidence that pressure has passed before re-adding risk.

This process differs from traditional markets, which have stable institutional players capable of absorbing shocks. In crypto, the lack of a healthy market structure means that each shock has a larger multiplier effect on overall liquidity.

Limited Innovation and Market Consolidation

Atkins believes that the crypto industry is entering a phase of consolidation rather than innovation expansion. “I do think that this industry is starting to reach a point of consolidation,” he said. Many core primitives of crypto are no longer new. “Uniswap and AMMs, as well as the AMM model, are not new concepts.”

The slowdown in crypto liquidity is more due to the absence of new innovative structures that attract ongoing engagement rather than funds flowing into other sectors. Crypto is experiencing a consolidation moment similar to the “LLM” phase in AI. Until the market can develop new mechanisms to absorb size, manage risk, and facilitate clean exits, new capital will remain cautious.

Bitcoin and Risk Assets: When Liquidity Matters More Than Narratives

Bitcoin ($87.99K, down 1.49% in 24 hours) surprisingly did not rise along with the recent decline in the US dollar. According to JPMorgan strategist analysts, the dollar’s decline was driven by short-term flows and sentiment, not fundamental changes in economic growth or monetary policy expectations.

Since the market does not see the current dollar decline as a sustained macro shift, Bitcoin is traded more like a risk asset sensitive to liquidity rather than as a reliable dollar hedge. This indicates that when liquidity decreases, even strong narratives are not enough to drive consistent price movements. Gold and emerging market assets are the main beneficiaries of dollar diversification because they have more mature liquidity and infrastructure.

This phenomenon proves that in the current crypto market consolidation phase, liquidity is king. No matter how good the narratives or how strong the project’s fundamentals, without sufficient liquidity to absorb large volumes, institutions will stay away, and the market will continue to operate fragily below its full potential.