Results Imminent: Data Interpretation of Potential Impacts on ETF Approval

Authors: Dessislava Aubert, Clara Medalie

Translation: Web3CN

Since the collapse of FTX, we have been closely monitoring crypto liquidity, which has seen a broad decline in trading volume and order book depth across all assets and exchanges. Even though the recent market rebound has failed to restore depth or volume to pre-FTX-collapse levels.

However, with spot ETFs potentially being approved as early as January, liquidity could see a real recovery soon (albeit with some negative implications). This could happen in two ways:

• Liquidity shifts via trading;

• Liquidity shifts via market makers (MM);

On the side of "ETFs will improve liquidity," there is a compelling argument that ETFs will expand the number of cryptocurrency traders, leading to higher trading volumes and more efficient markets. Market makers will also benefit from ETFs as a hedging tool and may expand their operations.

On the side of "ETFs will harm liquidity," the real concern is that large outflows from ETFs could exert selling pressure on the underlying market. For market makers, having more informed traders might lead them to charge wider spreads.

Let’s examine the state of Bitcoin liquidity to understand its potential impact.

Bitcoin Market Depth

The collapse of FTX led to a sharp drop in Bitcoin market depth. The sudden disappearance of FTX not only reduced liquidity directly but also prompted market makers—many of whom suffered heavy losses and faced difficult market conditions—to withdraw positions across multiple exchanges.

The 1% market depth metric measures the amount of buy and sell orders within 1% of the price on the order book. At this level, market depth across all exchanges and trading pairs dropped from approximately $580 million to about $230 million.

The recent market rally has had negligible impact on liquidity; the slight increase observed is primarily due to price effects.

Why is market depth important for ETFs? ETF issuers need to buy and sell underlying assets. While it remains unclear exactly where they will do so (spot exchanges, OTC desks, or miners), it is likely that at some point, traffic on centralized spot exchanges will increase, especially given that many ETFs could be approved simultaneously.

From an arbitrage perspective, liquidity is also crucial. ETF prices must track the underlying asset, achieved by buying or selling whenever premiums or discounts appear. Illiquid markets create more frequent pricing mismatches, complicating the work of arbitrageurs—thus, liquidity is vital for market efficiency.

U.S. cryptocurrency exchanges could play a particularly significant role in spot ETFs—they currently account for around 45% of global BTC market depth.

Throughout 2023, Kraken averaged the best BTC trading depth, with $32.9 million within the 1% price range, followed by Coinbase at $24.3 million. Binance’s daily average market depth is shown in red for reference.

ETF approval could also affect trading costs if more informed investors enter the Bitcoin market. Over the past year, trading costs incurred by users in the form of spreads have mostly improved compared to last year, possibly due to lower price volatility.

In summary, Bitcoin market depth has remained relatively stable for most of this year (indicating no change in liquidity), while bid-ask spreads have mostly narrowed (reducing trader costs)—but ETF approval could alter this situation.

Bitcoin Trading Volume

FTX’s impact on trading volume was much smaller than on market depth, accounting for less than 7% of global volume. Since November last year, volumes have fluctuated significantly. Volumes remained high during the first quarter of 2023 but plummeted after the banking crisis in March, hitting multi-year lows during the summer.

With the recent rebound, we’ve seen a slight recovery over the past few months, but overall, trading volumes remain far below pre-FTX levels.

Therefore, when comparing trading volume with market depth, we observe that since November 2022, the decline in depth has been much more pronounced, while depth has exhibited significantly less volatility throughout the year compared to volume. This suggests that market-making activity levels have remained constant, with no new entrants (or exits).

Bitcoin Dominance

Bitcoin remains by far the most liquid crypto asset and has proven the most resilient under harsh market conditions. ETFs could further solidify its dominance.

From the trading volume distribution over the past year, we can see that BTC’s volume averages three times that of ETH and more than ten times that of the top 10 altcoins. Notably, Binance’s zero-fee Bitcoin trading promotion, which ended in spring, amplified this trend.

Bitcoin’s average daily market depth is very similar to that of ETH, although it remains significantly larger than most altcoins.

Conclusion

Bitcoin is by far the most liquid crypto asset. However, both liquidity metrics have declined sharply since the FTX collapse, with only a modest recovery in recent months. Therefore, ETF approval is currently the biggest catalyst for the crypto market, offering significant upside potential with limited downside risk. Despite some liquidity risks, ETFs could comprehensively improve market conditions if investor appetite increases substantially.