CFTC-Binance Lawsuit Could Worsen Crypto Market Liquidity, Pull Bitcoin Down to $25K: Observers

Poor liquidity, a problem plaguing crypto markets since the collapse of FTX in November, could worsen, breeding price volatility as regulators go after dominant exchange Binance.

On Monday, the U.S. Commodity Futures Trading Commission (CFTC) sued Binance for running an alleged "illegal exchange" and a "sham" compliance program. The regulator, which is responsible for oversight of commodities and derivatives markets, including the derivatives tied to bitcoin (BTC), sued Binance CEO Changpeng Zhao and former top compliance executive Samuel Lim, alleging "wilful evasion" of the U.S. law.

Binance has long been the leading digital assets exchange and accounted for a much bigger share of the global trading volumes than its former rival FTX. Per Morgan Stanley, the exchange accounted for 81% of the total BTC traded on centralized exchanges in February. According to the case document, a single trader from Chicago is responsible for 12% of the total trading volume on Binance.

Observers, therefore, are worried that the lawsuit would bring a deeper decline in the market liquidity – a measure of how difficult or easy it is to trade large quantities at stable prices.

"The main worry is what this will do short-term to market liquidity - if market makers step back from trading on Binance now, and if Binance's U.S.-based trading desks have to stop operations, that will reduce liquidity in an already thin market," Noelle Acheson, the author of the popular Crypto is Macro Now newsletter, said.

"That will exacerbate volatility and could keep some large players on the sidelines for a while longer," Acheson added.

Liquidity is widely measured by a metric called the 2% market depth – a collection of the buy and sell orders within 2% of the mid-price or the average of the bid and the ask/offer prices.

The greater the market depth, the less likely that large buy/sell orders will cause significant deviations in the asset's market price. Market makers are entities that provide liquidity to a financial market by creating buy and sell orders that aren't executed immediately.

Bitcoin liquidity as measured by the order book depth slipped to ten-month lows on March 13.

Bitcoin's 2% market depth slipped to a ten-month low last week, extending the deterioration seen since FTX's sister firm Alameda Research, formerly one of the largest market makers, closed shop five months ago.

The situation will persist for a while, according to DRW-subsidiary Cumberland, one of the earliest and longest-standing crypto market makers.

"This lawsuit will certainly exacerbate tightness in the already-strained digital asset banking system, and as a knock-on effect, it will damage liquidity," Cumberland said in a tweet explaining the impact of the regulatory action on the market.

Pullback likely

Some observers expect bitcoin to revisit the former resistance-turned-support near $25,000 in the wake of the heightened regulatory uncertainty.

"It is clear that the CFTC wants oversight on all crypto exchanges. It's not something new, but the market is reacting prudently and we are still holding our breath for further negative news, which may push BTC down," Kssis told CoinDesk.

Long rekts [liquidations], which increased yesterday, will inevitably push prices down, possibly below support near $25,000," Kssis added.

Bitcoin fell by over 3% on Monday, hitting lows near $26,500 in response to the CFTC's action against Binance. The cryptocurrency has since stabilized around $27,000, having put in a nine-month high of $28,889 on March 23, CoinDesk data show.

Derivatives exchanges on Monday liquidated or forced closed bullish long futures positions worth more than $25 million, a sharp rise from Sunday's $3.6 million figure, according to Glassnode. Meanwhile, short liquidations amounted to just $7 million. Forced closures of long/short positions often add to bearish/bullish pressures around the cryptocurrency.

According to Acheson, the lawsuit is not good news for market valuation, as it adds "yet another layer of uncertainty and is not a good 'look' for the ecosystem, coming soon after another high-profile fraud."

Acheson, however, expects recent macroeconomic developments like increased expectations for a quick Fed pivot in favor of rate cuts to cushion markets from the negative impact of the Binance news.

"For BTC, ETH and other majors, we're seeing some selling interest that is supported by buyers coming in - this is a very different market than November, with a pivot in sight and new narratives motivating new types of investment decisions," Acheson noted. "Psychologically, it's not as much a blow as the FTX implosion since the market has been warned repeatedly that something like this was coming."