Crypto Markets Mirror Forex Volatility Amid Geopolitical Events

Cryptocurrencies, despite their innovative applications, are fundamentally currencies and thus subject to the same market dynamics as traditional financial instruments. As crypto becomes more mainstream, it mirrors the volatility of traditional markets, with liquidity playing a significant role in its price fluctuations.

The combined cryptocurrency market had a market capitalization of just over $3.3 trillion, with a daily trading volume of more than $275 billion. These numbers suggest a healthy market, but they mask an extreme fragility in terms of liquidity. During calm periods, liquidity appears robust, but it thins out during extreme conditions.

The foreign exchange market, often perceived as highly liquid with over $7.5 trillion in daily trading volume, also experiences this phenomenon. During volatile periods, liquidity rapidly evaporates, creating an illusion of market depth known as "phantom liquidity." This is particularly noticeable among the most liquid currency pairs, such as USD/EUR. Following the Great Recession, many banks exited from providing liquidity to foreign exchange markets due to rigorous capital requirements, shifting these risks to hedge fund managers, exchange-traded funds, and algorithmic market makers.

This structural mismatch has led to situations where liquid wrappers hold illiquid assets, exacerbating volatile conditions for Forex traders. The same phenomenon is observed in crypto markets, where the underlying liquidity on exchange platforms seems robust but instantly dries up during market sentiment shifts.

Volatility in crypto markets is often exacerbated by geopolitical events. For instance, recent airstrikes by Israel on Iran caused panic among investors, leading to a rapid sell-off in the stock market and a corresponding decline in crypto prices. Bitcoin fell more than 5% to under $99,000, while other cryptocurrencies like Ethereum, XRP, and Solana experienced even steeper declines.

One week later, the announcement of a ceasefire between Israel and Iran by U.S. President Donald Trump led to a sudden influx of capital into crypto markets, causing prices to jump across the board. This highlights the underlying liquidity constraints in the crypto market, where sudden capital inflows lead to significant price volatility.

According to Lingling Jiang, a partner with the crypto investment firm DWF Labs, the volatile price movements following these incidents underscore the need for a more robust liquidity architecture capable of absorbing large capital flows without excessive volatility.

The illusion of liquidity is even more pronounced with second-tier digital assets. The recent collapse of Mantra’s OM token is a case in point, showing that what appears to be a healthy market can rapidly dissipate when market sentiment erodes, leaving investors stranded with tokens that are suddenly next to worthless.

The fragmentation of crypto markets, scattered across numerous exchange platforms with their own order books and market makers, contributes to this illusion of liquidity. Because crypto assets are spread across multiple markets, they lack unified pricing, and the liquidity that underlies them is spread too thin.

The decentralized nature of crypto markets also attracts scammy projects and opportunists who artificially inflate trading volumes to give the impression of market depth. Activities such as wash trading and spoofing lead to inflated volumes, especially on smaller exchanges, often resulting in catastrophe when those assets are exposed.

To address these issues, there needs to be a complete overhaul of the underlying architecture, with cross-chain bridging embedded directly into the core infrastructure of blockchain. This approach, embraced by some Layer-1 blockchains, aims to unify liquidity pools and facilitate smoother capital flows across exchange platforms.

Blockchains have already made significant progress in solving questions around scalability, with many networks capable of processing thousands of transactions per second. These scalable networks must now focus on smarter interoperability and the unification of liquidity. With a strong foundation in place, the potential exists to link all of these high-speed networks together and build something robust enough to reinforce crypto asset prices during volatile periods.