Systemic Liquidity Risk in Crypto Markets: The Role of Market Makers During Extreme Volatility

The cryptocurrency market's October 2025 liquidation cascade-resulting in $19 billion in losses-exposed a critical vulnerability: the fragility of liquidity provision during extreme volatility. Market makers, typically tasked with stabilizing markets, instead exacerbated the crisis by withdrawing liquidity in a synchronized manner, creating a "liquidity vacuum" that turned a macroeconomic shock into a systemic collapse, according to a Forbes exposé. This event underscores the unique risks posed by crypto markets, where market maker behavior is shaped by asymmetric incentives, fragmented infrastructure, and the absence of regulatory safeguards.

Market Makers: Stabilizers or Catalysts?

In traditional markets, market makers operate within structured environments with circuit breakers and regulatory oversight to mitigate liquidity risks. However, crypto markets-characterized by 24/7 trading, high volatility, and minimal regulation-demand distinct strategies. Market makers in crypto rely on dynamic spread adjustments, automated market making (AMM), and delta-neutral hedging to navigate rapid price swings, as detailed in a Coinbound guide. Yet, during the October 2025 crash, these strategies failed to prevent a liquidity vacuum.

Blockchain analyst YQ noted that market makers began withdrawing liquidity just one hour after U.S. President Donald Trump's tariff threat was announced, effectively removing $700 million in assets from Binance's order books, as reported by the Forbes exposé. This withdrawal left bid-ask spreads widening to unsustainable levels, triggering cascading liquidations. A Binance co-founder later admitted that automated systems froze as order books thinned, leaving traders unable to close leveraged positions, the Forbes exposé also reported. The absence of legal obligations for market makers to maintain liquidity during crises further amplified the damage, according to a Gate analysis.

Academic Insights: Volatility, Risk Models, and Systemic Spillovers

Academic studies highlight the structural differences between crypto and traditional markets. For instance, the lack of a leverage effect in crypto-where investors often perceive volatility as an opportunity rather than a risk-contrasts sharply with traditional markets, as noted in a 2024 review. During the October 2025 crash, this dynamic led to a surge in leveraged positions, compounding the impact of liquidity withdrawals.

Risk modeling tools like Value-at-Risk (VaR) have also proven inadequate in crypto's extreme volatility. A 2024 study found that the Historical Simulation VaR model outperformed Delta Normal and Monte Carlo Simulation models during crises, yet even this approach struggled to capture the rapid, non-linear price movements. Meanwhile, "Daily Dynamic Tuning" strategies-adjusting model parameters in real-time-showed promise in adapting to crypto's volatility but remain underutilized, the 2024 study observed.

The interconnectedness of major cryptocurrencies further compounds systemic risks. Bitcoin and Ethereum, as primary sources of systemic risk, triggered cascading losses during the October crash, while Solana and Binance Coin bore the brunt of the fallout, the same 2024 study found. Stablecoins, though designed to absorb stress, revealed vulnerabilities, particularly algorithmic stablecoins like TerraUSD, which collapsed in 2022, as the Forbes exposé detailed.

Systemic Risk and the Path Forward

The October 2025 event demonstrates that crypto's systemic risks stem not from inherent flaws in the asset class but from structural weaknesses in market infrastructure. Unlike traditional markets, where interconnectedness between institutions historically amplified crises (e.g., 2008), crypto's risks arise from leverage, fragmented exchanges, and opaque stablecoin mechanisms, as noted in the Gate analysis.

Regulatory interventions are urgently needed. For example, mandating minimum liquidity thresholds for market makers during volatility events could prevent synchronized withdrawals. Additionally, improving transparency in automated liquidation (ADL) mechanisms-used by exchanges like Binance-would reduce disproportionate impacts on leveraged traders, the Gate analysis recommends.

Conclusion

The October 2025 crash serves as a cautionary tale for investors and regulators. Market makers, while essential for normal market function, can become catalysts for systemic risk during crises. Addressing this requires a dual focus: refining risk models to account for crypto's unique volatility and implementing regulatory frameworks to ensure liquidity resilience. As the market capitalization of crypto approaches $4 trillion, the stakes for systemic stability have never been higher, the Forbes exposé warns.