Why Lack of Diversification Crippled Crypto Markets

Bitcoin and Ether, the giants of the cryptocurrency market, currently account for over 60% of its total market cap, surpassing the combined value of all other coins. However, the lack of diversification poses significant concentration risks. Any significant slowdown in the performance of Bitcoin and Ether has a ripple effect that impacts the entire market.

In order to offset this dominance and mitigate the associated risks, it is imperative to build a robust infrastructure that enables the continued introduction of tokens. Unfortunately, this is a challenge due to the reliance on centralized exchanges which lack transparency. These exchanges often operate without proof of reserve requirements, effective liquidity management, or adequate due diligence.

Recent events have highlighted the dangers of this approach. To overcome this risk, we need infrastructure improvements that emphasize transparency and sustainability. Instead of relying on exchanges like FTX and Alamedas, we need market makers and exchanges that allow token issuers to make independent decisions.

Market making plays an important role in this scenario. Innovative forms of market creation have emerged, allowing smaller tokens to enter multiple markets and increasing diversity. This reduces concentration risk and increases liquidity while freeing token issuers from opaque third-party intermediaries.

The readability of Bitcoin and Ether has significantly contributed to their dominance. Investors easily understand and analyze these assets, capturing their interest with predictability and transparency. Moreover, its high liquidity facilitates efficient trading.

However, the dominance of BTC and ETH is also a challenge. With only two assets accounting for more than half of the market cap, investors are often hesitant to invest in smaller coins or assets. The lack of portfolio diversification perpetuates the dominance of Bitcoin and Ether, creating concentration risks. These adverse events or regulatory actions affecting the dominant cryptocurrency have far-reaching consequences across crypto markets, as observed in the 2022 FTX crash.

Excessive volatility further adds to the challenge. The recent collapses of Terra-LUNA, FTX, Silvergate and Silicon Valley Bank have demonstrated the devastating effects of prolonged volatility in the market, with slow recovery times. Such downside risks erode investor confidence and industry credibility. The impact of asymmetric volatility on BTC and ETH has also hindered the market’s recovery, as prices tend to fall faster than they rise.

This excessive volatility discourages large funds and investors from actively participating, thereby reducing liquidity. Additionally, the extreme volatility of cryptocurrencies limits their adoption in traditional financial applications such as loans, mortgages, and insurance. To prevent another liquidity crisis and solve this problem, the crypto market needs innovative market making practices and technological advances that prioritize transparency and sustainability.

The dominance of Bitcoin and Ether is a symptom of a bigger problem—the inadequate infrastructure of autonomous markets. Smaller tokens face challenges in maintaining trading volume, resulting in limited resources for blockchain infrastructure and reduced liquidity. The lack of transparency and stability forces issuers to rely on external exchanges and market makers, relinquishing control over the performance of their token markets.

To remedy this situation, investing in technology and infrastructure that promotes transparency, autonomy and sustainability is essential. Such advancements will enable token issuers to monitor their assets and trading activity in real-time, increasing the readability of their assets. This investment will promote diversification, restore market stability, and align with the basic values ​​of trust, security, decentralization, and fair access that underpin the crypto industry.

Increasing the number of tokens alone does not solve the risk of concentration, volatility and reduced liquidity. Quality remains paramount, prioritizing tokens with value and purpose. Nonetheless, empowering token projects and communities with greater visibility and agency, allowing them to operate without intermediaries, could revolutionize the marketplace. By attracting more investment, these tokens can challenge the dominance of BTC and ETH, leading to a more robust and diverse cryptocurrency market that benefits investors, the industry and society as a whole.