Is There a Bitcoin Supply Crunch as Liquidity Jumps?

The liquidity in the crypto market has improved following the launch of US spot Bitcoin ETFs amid concerns about a potential supply shortage due to increased demand from the ETFs.

Crypto enthusiasts have stated that the increased demand from recently established funds is at least ten times greater than the number of new tokens being created by miners.

This surge in demand has driven the largest cryptocurrency to rise by over 20% this year.

Significance of market depth

Market depth is a measure of liquidity that refers to an investor's capacity to handle orders without causing substantial price changes. In essence, it measures the depth of an order book, showing how many buy and sell orders exist at different price levels.

For instance, if there is high market depth, it means there are substantial volumes of buy and sell orders at various price points, indicating a liquid market where trades can be executed without drastically affecting prices. On the other hand, low market depth implies a shallow order book with fewer orders, making it easier for large trades to impact prices significantly.

In the context of cryptocurrency exchanges, higher market depth signifies a more robust and liquid trading environment, which is generally desirable for traders and investors. It provides confidence that orders can be executed efficiently and at fair prices, reducing the risk of price manipulation or slippage during trades.

How do spot Bitcoin ETFs contribute to liquidity in the crypto market?

Spot Bitcoin ETFs contribute to liquidity in the crypto market by providing investors with a regulated and easily accessible avenue to gain exposure to Bitcoin without directly owning the underlying asset. These ETFs invest in physical Bitcoins, which means they hold the actual cryptocurrency rather than futures contracts or derivatives. As a result, when investors buy shares of a spot Bitcoin ETF, the fund manager typically purchases an equivalent amount of Bitcoin, thereby increasing demand for the cryptocurrency.

But liquidity on centralized cryptocurrency exchanges, as shown by the 1% market depth, has risen following the introduction of spot US Bitcoin ETFs on January 11.

"Spot Bitcoin ETFs have attracted substantial investments, with a considerable portion of the funds believed to come from redemptions transferred from the Grayscale Bitcoin Trust to more cost-effective competitors," said a trader.

Since its conversion from a trust, the $24 billion investment fund has experienced around $7 billion in withdrawals. Bankrupt crypto firms, including FTX exchange and Genesis lender, are among the major investors of GBTC.

Increased selling pressure may come if firms redeem shares and repay creditors.

Additionally, miners have been selling more owing to a planned Bitcoin code upgrade known as "the halving," which is expected to decrease mining profitability significantly.

Another possible explanation for the recent rise is the confidence felt by momentum traders seeking a short-term peak before favourable macro events like rate cuts and economic support measures.