In this week’s Market Spotlight blog, we reflect on the macroeconomic data that came out in the last couple of weeks and address the concerns regarding the declining liquidity on centralised exchanges.

This blog was created using CCData’s award-winning research and data. You can learn more about our data solutions here.

State of the Market

It’s been an eventful start to the month, with the Federal Reserve announcing a .25% interest rate hike to 5.25% — the 10th hike in 14 months. There has been a lot of speculation on whether the most recent hike would be the last before a pause after the Federal Reserve omitted prior language that signaled there would be more hikes ahead.

Major digital assets, including Bitcoin and Ethereum, have recently struggled to break key resistance levels at $30,000 and $2,000, respectively. As an asset with a higher beta, it is likely that digital asset investors and traders will try to front-run any indication of a potential pivot from the Federal Reserve before the actual catalyst.

During the interest rate announcement and subsequent press conference, there was a noticeable fluctuation in the open interest and funding rates. Open interest notably surged by 6.15% to $9.57bn within the next 24 hours, while the hourly funding rate turned positive suggesting the optimistic sentiment in the market.

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The markets responded positively to the latest CPI announcement, which beat estimates and recorded its tenth consecutive decline to 4.9%. Following CPI, Bitcoin reclaimed the $28,000 mark with a surge in open interest and funding rates reflecting a more positive market outlook.

Although crypto assets have recovered well in terms of price action (reclaiming pre-FTX collapse levels), it is still early to say whether the worst is over in the current downtrend. After all, bear market rallies are a common theme during a turn with the resemblance of Bitcoin’s current price action with its 2018–19 performance likely to strike a fear among investors.

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Historically, the month of May has not been kind to the industry. In 2021 we saw China’s crackdown on Bitcoin mining and a year later, the collapse of TerraUSD — both of which resulted in 35.4% and 15.6% monthly drawdown, respectively. If lightning were to strike for the third consecutive year, the next black swan event could be more severe due to low liquidity on centralised exchanges.

As mentioned above, one of the main concerns for investors using centralised exchanges is the decline in market liquidity — a common trend since 2022.

For example, the BTC-USDT pair on Binance, which is the most popular trading pair by trading volume, has seen its market depth fall to the lowest levels since May 2022. This trend could be further insinuated by key market makers, Jane Street and Jump Crypto, pulling back their interest in crypto following the stringent regulatory climate in the US. As such the overall liquidity on centralised exchanges could be adversely affected further in the coming days.

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A key consequence of low liquidity on centralised exchanges is the high volatility of crypto assets, as any market order of reasonable size will absorb limit orders on both sides. We have seen an indication of these with the fake alerts of a possible selling of Bitcoin held by US Governments, which caused markets to tank twice in a matter of few weeks.

These concerns are justified as the US Government currently holds 69,370 BTC, therefore, any potential selling could not be an ideal scenario, especially with the current liquidity on centralised exchanges.

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Looking into the futures open interest to market cap ratio of Bitcoin, the data suggests that there has been a spot accumulation of Bitcoin with the ratio declining by 21.3% to 1.67% since the start of the year (as of May 7th).

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However, speculation remains the driving theme overall with derivatives trading accounting for an all-time high market share of 77.6% of the trading volume on centralised exchanges as of April.

Open interest on centralised exchanges has also risen to the highest levels since May 2022 (before the collapse of TerraUSD). Binance, the largest derivatives exchange with a market dominance of 72.6%, has seen its open interest rise 62.6% to a peak of $11.4bn during April.

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With Coinbase and Gemini, two established spot markets entering the derivatives market in May, the market dominance of derivatives trading is set to increase further.

Asset Focus: Memecoins

With speculation at an all-time high, meme coins took central stage in May. For example, Pepe, a token named after a popular frog meme on Twitter, has reached $1.65bn in market capitalization (at its peak) in a couple of weeks. This has led to an inflow of trading activity on Uniswap, which has now overtaken all centralised exchanges excluding Binance in trading volume for the fourth consecutive month.

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In a P2P market, where the liquidity is thin, and there is no external capital flowing in, a surge in open interest and trading volume on meme coins is borrowed from other tokens. Since May 4th, the PEPE token was the third largest token traded on top-tier exchanges excluding stablecoins, eclipsing major layer-1 coins including Solana, Avalanche, and Binance Chain.

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However, one of the drawbacks of a highly speculative market is that when the music stops, there will be a large set of traders and investors catching falling knives. Pepe has already seen its price fall 60% from its peak last week, creating a new set of bagholders.

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