What Bitcoin Market Fragmentation Means for Its Future

Bitcoin market fragmentation makes the token less liquid and less fungible — a problem institutional investors can’t ignore


Source: Shutterstock


key takeaways

  • If global bitcoin market fragmentation were to remain unaddressed, it could hold back the market’s maturity
  • If crypto markets were regulated like commodities markets, there would likely be capital reserve requirements that prevent lending institutions like Celsius from over leveraging customer deposits

As of July 2022, there are 498 crypto exchanges. No two exchanges have the exact same price quote for bitcoin at any given time.

This creates problems for institutional investors, liquidity, and bitcoin’s fungibility, as well as its future.

For insight into bitcoin’s market fragmentation, what it means, and potential solutions, we spoke with the team at Apifiny.

Bitcoin market fragmentation 

In traditional markets, asset trading takes place within a regulated framework established by some kind of financial authority. In crypto markets, exchanges use bids and asks in an order book to determine their own price.

Because these exchanges lack a central regulatory body, there lacks a hierarchy of pricing authority.  There is no singular metric that anyone can point to and say “this is the price of bitcoin right now.” The closest alternative is an aggregate price indicator that averages prices across some exchanges.

We spoke to Haohan Xu, founder and CEO of Apifiny, for more on bitcoin market fragmentation.

Haohan began by defining fragmentation as “the disconnected and scattered marketplaces in crypto.” He went on to note that crypto exchanges are regional and tend to “dominate their respective markets with respective fiat currencies.” In such markets, prices tend to conform to their regional supply and demand, or as Haohan put it: “…This creates many isolated liquidity pools for Bitcoin. Each exchange essentially is their own marketplace, and participants in each marketplace are only trading amongst themselves and have a very hard time utilizing liquidity from another exchange.”

This kind of market structure prevents many institutional investors and professional traders from getting the best price for and desired liquidity of Bitcoin and other cryptocurrencies at any given time. One solution is to use smart order routing to find the best price. Apifiny includes this tool in one of their service offerings, Apifiny Connect, but is working toward comprehensive solutions to fragmentation.

The state of bitcoin fungibility

Fiat currencies are fungible. The value of a dollar is the same in California, New York and across the globe.

Bitcoin market fragmentation, on the other hand, makes it less fungible. The price varies from exchange to exchange. And because the number of exchanges is rapidly changing across the globe, the price of bitcoin also varies from region to region. This lack of fungibility can create issues for those working with large amounts of capital, as Haohan described:

“If you’re trying to buy a large order of Bitcoin at one time, let’s say 10 Bitcoin. A single exchange does not have enough liquidity to execute that trade with minimal price slippage. So, you want to try to execute that across multiple exchanges at the same time, but a couple years ago there just wasn’t any infrastructure to do that.”

Liquidity challenges

In 2022, a crypto liquidity crunch caused cascading consequences throughout markets. The current bear market or “crypto winter” has been marked by many exchanges and borrowing/lending platforms suspending withdrawals and filing for bankruptcy.

Crypto companies like Celsius Network, Three Arrows Capital, Voyager Digital, CoinFLEX, BlockFi, Bancor, Babel Finance and Vauld were all affected in one way or another. And as a result, they were forced to liquidate any assets they could to pay off debts. Fragmented markets exacerbate this type of sell pressure because they make it difficult to move liquidity where it is needed most.    

For example, massive sell pressure from a liquidation event can cause dramatic price slippage on illiquid exchanges — meaning the large market order pushes down the price it is sold at. As a result, a single trade can produce a major price imbalance between exchanges. Arbitrage traders may be able to fill in the gap, but this tends to exaggerate losses as it incites more fear and perpetuates the liquidity crisis.

If crypto markets were regulated like commodities markets, there would likely be capital reserve requirements that prevent lending institutions like Celsius from over leveraging customer deposits. But this would not solve the price fragmentation problem. Bitcoin price discrepancy is a consistent reality, regardless of liquidity crises. 

In 2021, Taylor and Francis Online published a report from Jakob Albers highlighting the persistence of bitcoin market fragmentation. Order book data they gathered across a sample of exchanges indicated that exchanges with higher volume and liquidity consistently lead the smaller exchanges in price movement. This demonstrates that price fragmentation is a consequence of liquidity fragmentation. 

The future of bitcoin 

If global Bitcoin market fragmentation were to remain unaddressed, it could hold back the market’s maturity. Typically, as assets evolve, they gain liquidity and become more regulated, which helps to reduce volatility. According to Haohan, continued fragmentation could mean Bitcoin remaining volatile for the time being:

“All the smaller exchanges, when there’s less liquidity, will lose lots of bids and asks being thrown around and during volatile times, prices can change a lot. So, over the years, if the issue of fragmentation doesn’t get addressed, Bitcoin will continue to be a very volatile asset.”

How can this be addressed? The answer could involve a mix of both regulation and innovation. The two rely on each other to some degree. As Haohan put it, “regulation can’t solve any of this without the proper tools and obviously, innovators are the ones that bring the tools. But innovation needs regulation and so regulators…might say ‘I want to regulate crypto in a certain way’, but if the tools to do that simply don’t exist, there’s not much they can do.”

It all comes down to addressing liquidity fragmentation by uniting the settlement systems of different exchanges. Haohan explains: “the fragmentation actually exists in the clearing settlement layer, not in the markets layer. So, let’s say you unite the wallet systems or the clearing settlement systems of Coinbase or Gemini, then that trader can use their funds to trade on both Coinbase and Gemini and there wouldn’t be so much of a price discrepancy issue, because they’re all in the same ecosystem.”

We asked Haohan what Apifiny is doing to solve these issues. He replied: “We’re focused on building the infrastructure for professional traders or institutions to access the complete route to the market in the most seamless way possible. So, our end goal here is using strong infrastructure as a method to consolidate and glue together a complete crypto market so that traders can have one-stop access from price discovery and liquidity; cross-trading venue fund rebalancing and management; to post-trade reporting and analysis.”

Apifiny has been working hard to address one of the biggest challenges for the crypto market. It requires a delicate synergy between innovation and regulation. But once the two reach a clear and ubiquitous solution, they have the potential to unlock a massive wave of adoption. Solving market fragmentation will lead to price stability and real world utility. Companies will be more willing to use it to conduct business, financial advisors will feel more inclined to recommend digital assets to clients, and consumers will be attracted to its ease of use and store of value.

This content is sponsored by Apifiny.

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