V. Limited Liquidity

Limited liquidity is a persistent challenge in traditional financial markets, particularly in less liquid asset classes and during periods of market stress. Regulatory changes, risk aversion, and the inherent characteristics of certain instruments all contribute to reduced liquidity.

Decentralized finance (DeFi) platforms also face significant liquidity issues, making it difficult for users to buy or sell assets without large price changes. Low liquidity can cause slippage, where users receive less than expected for sale, especially in pools with limited capital. For example, if only $10,000 is locked in a liquidity pool, a $1,000 sale could impact prices by nearly 10%.

Automated market makers (AMMs) also expose liquidity providers to impermanent loss due to price volatility, discouraging participation. By 2023, the total value locked (TVL) in DeFi dropped around $40 billion, reflecting shrinking liquidity and highlighting the risks in the DeFi space.