The recent crypto rally, dubbed “uptober,” has caught the attention of many investors. Bitcoin (BTC) has surged over 35% since October, while assets like Chainlink (LINK) and Solana (SOL) have seen even greater gains. However, it is important to examine the liquidity trends that underpin this price action in order to understand where we stand in the market cycle and what the future may hold.
Low trading volumes often result in less reliable price indicators compared to higher volumes. When trading volumes are low, it suggests limited market participation at a particular price level, which can lead to greater price volatility and reduced market depth. On the other hand, higher trading volumes indicate broader market participation, suggesting a stronger consensus and providing a more reliable basis for price movements. Therefore, it is crucial to analyze trade volume recovery to gain insights into the market.
BTC and ETH, the most closely watched liquidity metrics, have seen a significant recovery in trade volumes. During the recent rally, two of the top 15 trading volume days since the market peak two years ago were recorded. Most of the other high-volume days occurred during dramatic company failures in 2022 or when several mid-sized U.S. banks faced difficulties in March 2023. BTC spot volumes, which hit three-year lows until September, have experienced a steep recovery and are now approaching six-month highs. However, this is just part of the story.
Taking a deeper look into liquidity trends reveals strong activity in derivatives, particularly in CME Futures open interest (OI) for BTC and ETH. This metric has recently crossed the $20 billion mark for the first time since the FTX meltdown in November 2022. The excitement surrounding the highly anticipated U.S. spot ETF launch has driven this increase, with institutional capital leading the way. The CME, a popular venue for large traditional finance companies to gain exposure to crypto, has gained the most market share among all venues and is close to surpassing Binance as the leading BTC futures exchange by OI. A similar trend can be observed in options, with BTC options open interest surpassing $16 billion and volumes reaching all-time highs. Much of this activity translates into spot prices as a significant portion of these flows are likely hedged into spot.
However, the growing derivatives market also brings inherent risks, particularly in terms of leverage. With more leverage in the system, the risk of forced liquidations exacerbating price movements is likely to increase.
Examining spot order books reveals a relative lack of sellers despite the tightening of liquidity. Order book depth, which measures the amount of capital required to change the asset price by a certain percentage based on the limit orders in place, has decreased over the past few months despite the strong price increases. The sell side of the order book is shrinking more than the buy side, indicating a shortage of sellers compared to buyers.
The combination of busy derivatives dynamics and a tight spot market is an interesting development. Although volatility has picked up recently, it remains relatively low for both BTC and ETH. The annualized realized volatility, using a seven-day lookback period to capture the recent price surge, has not exceeded 63%, which is below the median value during the previous bull market in 2020 and 2021. Volatility plays a crucial role in liquidity as it usually drives higher trading activity. BTC’s current spot volumes adjusted by volatility are already in the top quartile of the 2020/2021 bull market cycle.
The current rally feels different due to increased interest from traditional institutional investors and a market with relatively few sellers amid increasing but still relatively low volatility. These factors suggest that the market may be shifting gears into a new phase. While interim corrections and the uncertain macro environment may still pose challenges, this rally could potentially mark the start of the next bull market.
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