Article Summary
- Analysis of the fragmented liquidity structure in the crypto market and its impact on liquidation risks.
- Case study of the USDe crash on CEX in October 2025 and how liquidity constraints exacerbated the issue.
- Proposal of a circuit breaker mechanism based on composite quantitative indicators to provide a liquidity adjustment window and prevent excessive liquidation.
Introduction
The cryptocurrency market has experienced significant volatility, exemplified by the USDe crash on CEX to $0.65 while its on-chain price remained at $0.99. This event highlights the cascading liquidation risks resulting from liquidity fragmentation in the market. Under low-liquidity conditions, automated liquidations can have a devastating impact, especially with bottlenecks in deposit and withdrawal channels. This article aims to propose a circuit breaker mechanism based on composite quantitative indicators such as price deviation, order book depth, and large-scale liquidation exposure as reference conditions for triggering. This mechanism aims to provide a market adjustment window, allowing market makers to overcome operational frictions like large withdrawals/deposits and chain congestion, and inject external liquidity. Ultimately, through an orderly restart of trading, this mechanism prevents vicious liquidation cycles, safeguards market structure stability, and mitigates the severity of positions that do not need to be liquidated.
1. The Fragmented Structure of Crypto Market Liquidity
1.1. Crypto Market Liquidity Map: CeFi, DeFi, and Cross-Chain Isolation
The unique liquidity structure of the crypto asset market is the origin of its inherent risks. Liquidity is highly dispersed, spanning CEXs, DEXs, and various types of DeFi. This liquidity isolation forms a fragmented ecosystem, and the frictions between different liquidity pools (such as high on-chain transaction fees, complex cross-chain bridging times, and CEX review or lock-up mechanisms for large deposits and withdrawals) greatly impede the free and rapid flow of capital. This structural friction is a major reason why local liquidity crises can quickly escalate and cannot be repaired in a timely manner by arbitrage activities.
1.2. Market Maker Behavior and Risk Spillovers in Extreme Market Events
When the market fluctuates sharply, liquidity providers (Market Makers) quickly withdraw limit orders, leading to a widening of the Bid-Ask Spread and a sharp depletion of the Depth of Market. When liquidation cascades occur, liquidation engines and liquidation robots trigger forced closures. These forced closures often manifest as large-volume market orders, which are indiscriminately sold in the thinly traded order book, further depressing prices. This failure of the market mechanism separates the price discovery process from fundamentals, entering a self-reinforcing liquidation feedback loop.
1.3. Positioning of the Circuit Breaker Mechanism: From Passive Suspension to Active Liquidity Management
The core value of the Circuit Breaker mechanism lies in providing an active risk isolation and liquidity reallocation event window when market liquidity is low. The essence of a circuit breaker is to temporarily suspend trading activities to prevent flash crashes driven by automated trading systems and panic from worsening in the event of low liquidity. Through precise algorithm triggering, the circuit breaker mechanism quickly isolates risks and establishes a set of operating protocols to ensure that external capital can quickly and smoothly return to the market, thereby rebuilding liquidity depth when trading resumes.
2. USDe Event on October 11, 2025: An Anatomy of Local Liquidity Failure
2.1. Price Discrepancies of USDe on CEX and DEX: Chain Reactions Caused by Local Faults
From October 10 to 11, 2025, the cryptocurrency market experienced the largest deleveraging event in history, with over $19 billion in leveraged positions being liquidated in less than 24 hours. The destructive power of this sharp market downturn mainly came from the high leverage in the market and the joint failure of the exchange's risk mitigation mechanism. According to publicly available data, the market decline sequence is as follows:
- 20:50 UTC, Oct 10: External shocks (such as tariff threats) caused market turmoil, and liquidity became thinner.
- 21:20 – 21:21 UTC, Oct 10: BTC and ETH prices fell to intraday lows, and systematic selling peaked.
- 21:20 – 21:42 UTC, Oct 10: Ethena's USDe began to fall below $1 on the Binance spot market.
- After 21:36 UTC: A serious decoupling event occurred, and liquidation cascades began to intensify.
- 21:42 – 21:51 UTC, Oct 10: USDe price bottomed out ($0.65) on Binance, while other assets such as wBETH and BNSOL also experienced significant price gaps with ETH and SOL.
2.2. What Hinders Liquidity: Time, Network, and Operational Obstacles
In times of extreme volatility, arbitrage activities face multiple "channel bottlenecks," making it impossible to bring liquidity back into the market in a timely manner. These obstacles include:
- Settlement time and network congestion.
- CEX operational restrictions.
3. Design of the Circuit Breaker Trigger Algorithm: Composite Quantitative Indicators
To respond to the unique high-frequency and dispersed characteristics of the cryptocurrency market, the trigger mechanism must transcend the single index plummet threshold of traditional financial markets.
3.1. Indicator 1: Cross-Platform Reference Price Deviation (CVD) and its Exponential Construction
Introduces a multi-source weighted aggregated price index based on multiple high liquidity to resist the internal pricing failure of a single CEX.
3.2. Indicator 2: Order Book Depth and Liquidity Impact Shock (DOM / Slippage Shock)
Price changes are a result, and liquidity depletion is the cause of structural failure. Therefore, the circuit breaker mechanism must directly monitor the health of the order book.
3.3. Indicator 3: Trading Speed and Liquidation Risk Exposure
In addition to the above structural indicators, the circuit breaker mechanism also requires the inclusion of an indicator for large-scale liquidation exposure.
4. Operation of the Circuit Breaker Stage: Liquidity Injection and Risk Isolation
Once the circuit breaker algorithm is triggered, the market enters a suspended state for N minutes. The success of this stage depends entirely on whether the exchange and market makers can eliminate the bottlenecks in the liquidity filling channel and control measures during this time.
4.1. Dynamic Calibration Model of Circuit Breaker Window N
The setting of the circuit breaker window N must meet the need to overcome the longest and most critical liquidity transfer friction.
4.2. Priority Injection Protocol for Designated Liquidity Provider (DLP)
During the circuit breaker period, the exchange must activate an Out-of-Band Capital Protocol (OBCP), for exclusive use by Designated Liquidity Providers (DLPs).
4.3. Risk Isolation and Liquidation Suspension Mechanism
After the circuit breaker is triggered, the following risk isolation measures must be implemented immediately:
- Full suspension of liquidation
- Collateral value lock-in
5. Trading Recovery Mechanism: Quantitative Safety Standards and Orderly Restart
The end of the circuit breaker should not depend on a scheduled time, but on whether liquidity has returned to its normal value. If the market is recklessly restarted when liquidity has not yet recovered, it may lead to greater price gaps and secondary panic.
5.1. Quantitative Prerequisites for Restoring Trading
The prerequisite for lifting the circuit breaker is that the order book depth and cross-platform price discovery mechanism return to a healthy level.
5.2. Phased and Orderly Restart Process: Silent Period and Auction
To prevent confusion and price gaps when trading resumes, the exchange should adopt an orderly and phased restart mechanism, similar to the auction process in traditional financial markets.
6. Some Ranting
The circuit breaker mechanism, by introducing a time isolation window (N minutes), actively compensates for the systemic vulnerabilities caused by liquidity isolation and operational frictions during extreme volatility in the cryptocurrency market.
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