A crypto liquidity crisis hit harder in a bear market when stakeholders in the industry are taking measures to minimize the impact of the continuous downtrend. Everyone must protect themselves from the unpredictable ups and downs during this period in the cryptocurrency space. Failure to take important measures could lead to being wiped away into irreparable losses. Learn how to stay safe from liquidity crunches in this article.
A Bit About Liquidity and Crypto Liquidity Crisis
Liquidity is the ability and ease with which an asset can be converted to other assets. The most liquid assets are fiats like the U.S. dollar, which you can exchange for whatever you want. Fiat currency liquidity explains why the most liquid assets in crypto are stablecoins since they often have a 1:1 value with a fiat currency like the US dollar. A crypto liquidity crisis happens when depositors or customers request to withdraw more funds than the balance available on an exchange. Such experiences can be worse for users in a bear market. These withdrawal requests are often so many that they sometimes congest the exchange servers. Due to the withdrawal pressure, the exchange would become insolvent if they processed such transactions simultaneously.
How Does A Crypto Liquidity Crisis Happen?
A liquidity crisis mostly results from the extra financial activities of the exchange. These exchanges often engage in additional financial services. Such activities include lending funds to other traders and sharing the interest with the depositors.
The law in most countries requires exchanges to be transparent in handling user funds. Exchanges are also required to maintain reserves to liquidate the user assets at any time, as there is no prior agreement regarding the withdrawal terms.
A liquidity crunch often results when a nonfeasance exchange violates one of these requirements. The violation may go unnoticed until the users are tipped off mostly through journalistic investigations. The ensuing events are often too much for the exchange, as tons of withdrawals and selloffs of native assets lead to a crunch.
FTX: A Complete Bear Market Disaster
The most recent liquidity crunch in the crypto case is the FTX scandal that cost users over $10 billion. The exchange violated its users on multiple levels by using their funds in its trading activities and declaring assets in a magically created token, FTT. Alameda Research, the trading arm of FTX, often received funds from the FTX exchange to facilitate its trading activities. No one knew about this, but it appeared they took significant losses on trades unknowing to unsuspecting users.
The exchange did not make this transparent, and the CEO of Alameda Research denied their illiquidity, stating that they had other assets. A later report by CoinDesk showing the exchange’s balance sheet proved that so much was not sitting well.
FTX had an asset declaration of $8 billion in FTT, a token with an overall market capitalization of just over $2 billion. Binance, an early investor in the exchange, noticed the issue and said it was selling its FTT tokens worth $500 million in the open market. Alameda’s CEO Caroline Ellison countered in a Tweet that they would happily buy Binance’s FTT at $22 each while the token was selling for $26 at the time.
Traders sensed the discrepancy and potential opportunity and started short-selling FTT. The value of the FTT portion of FTX’s balance sheet slid near zero, and customers were initiating withdrawals worth millions of dollars in one day. The exchange eventually halted withdrawals, saying they were doing all they could to resolve the issue.
During the halt, some hackers took advantage of the situation to exploit the exchange, making way with over $600 million. Onlookers on Twitter thought withdrawals had been restored until hours later when Sam Bankman Freid, CEO of FTX, announced that the exchange and related companies had voluntarily filed for chapter 11 bankruptcy. The bankruptcy filing protects companies while they do their best to reimburse users.
Why You Should Use Your Funds on Decentralized Exchanges Like Pandora
No one needs to tell you again that if it is not your keys, it is not your money. Centralized exchanges do not hold your funds for you. Instead, your funds are stored in a smart contract that works according to your terms. Using financial products on decentralized exchanges lets users invest objectively by trusting in the maths.
Liquidity on decentralized exchanges like Pandora is also transparent and traceable on the blockchain. Before executing the trade, you can check if a liquidity pool has enough funds for tour trade on popular DEX scanners. Transactions on decentralized exchanges are transparent, and users can track the movement of assets anytime.
Unlike centralized exchanges that could divert funds into personal use, decentralized exchanges like Pandora exist to serve their users. The exchange relies on code and math to demonstrate commitment instead of asking to be trusted with user funds.
Pandora’s unique swapping, farming, and reward features are designed to make the DeFi investment process simple and accessible to users of all sundry. For every transaction you make on Pandora, you get rewarded in the platform’s native token and EXP determined by the eligibility of the tokens you swapped.
Pandora exchange also features deep liquidity, offering users many options and the best rates on each swap. Yield farming on Pandora is second to none, with high returns paid promptly and claimable anytime. Recently, the first on-chain NFT Securities was launched. It is backed by traditional finance through a partnership with NVC group to offer Pandorans stable and reliable passive earnings.
Meanwhile, all users get huge chances to participate in potential earning opportunities by using the platform and earning EXP through hashrate-eligible trades, DroidBots upgrades, NFT trading on PandoMarket, buying tickets, unlocking staking slots, and opening PandoBoxes.
Conclusion
Liquidity crunches can reduce centralized companies to nothing in minutes. Sadly, unsuspecting investors and users will have no way to get their funds back.
Even though the founders of such exchanges end up in jail, losing such a life-changing amount of money during a bear market will leave users of centralized exchanges demoralized and miserable. The emotional damage from losing hard-earned money is not something anyone should go through. It is advisable, especially in a bear market, to use only exchanges like Pandora and keep your funds within reach.
These materials are for general information purposes only. They are not investment advice, a recommendation, or solicitation to buy, sell, or hold any digital asset or engage in any specific trading strategy. Some crypto products and markets are unregulated, and you may not be protected by government compensation and/or regulatory protection schemes. The unpredictable nature of the crypto asset markets can lead to loss of funds. Tax may be payable on any return and/or on any increase in the value of your crypto assets, and you should seek independent advice on your taxation position.
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