Based on the Coinmarketcap statistics, the overall number of issued digital assets is rapidly moving towards 11,000. Meanwhile, beginner investors and traders face headaches related to which cryptocurrencies are worth investing in. The factor of liquidity is of the highest priority for newer entrants. Let’s read “What is cryptocurrency liquidity? How to understand the liquidity of a crypto exchange?” below to find the reason.
What is Cryptocurrency Liquidity?
The term liquidity is generally used in financial markets to describe the ease by which an asset can be converted into cash without difficulty. In terms of cryptocurrencies, liquidity is the ability of a coin to be easily converted into cash or other coins.
Liquidity is essential for all tradable assets, including cryptocurrencies. Low liquidity levels mean that market volatility is present, causing spikes in cryptocurrency prices. On the other hand, high liquidity means there is a stable market with few fluctuations in price.
It is thus easier to buy or sell cryptocurrencies in a liquid market since buy or sell orders will be filled more quickly due to the more significant number of market participants. Essentially, this means it is possible to enter or exit a trade at any moment, given the fast-paced nature of the cryptocurrency markets.
For example, in your e-wallet, there are five types of tokens, and their price has increased in the past few days. Therefore, you decide to sell all existing tokens at the current market price.
If there is high liquidity in the marketplace, which means enough buyers are willing to buy your tokens at the desired price, you can quickly sell your tokens at the price you expect. Your transactions do not affect the token price because the market is liquid enough to make this transaction.
However, if you ask to sell all five tokens at the current market price but with low liquidity in the marketplace, there are not enough people to buy the tokens at the desired price. Therefore, you have to discount or wait until there is enough liquidity in the marketplace to sell your tokens. If you decide to sale in a low cryptocurrency liquidity market, your transaction also affects the current market price of the token.
How to understand the liquidity of a crypto exchange?
One of the critical factors affecting liquidity in the cryptocurrency market is trading volumes. You can check out any cryptocurrency market cap rankings website to see daily volumes, with a higher volume indicating that more people are buying and selling coins. Inadequate knowledge and clear-cut guidelines by authorities have so far limited these activities mainly to enthusiasts, but interest in bitcoin trading and cryptocurrency trading, in general, is attracting more and more people to get started.
A higher number of cryptocurrency exchanges provides more opportunities for more people to trade their coins, and in recent years the number of exchanges has multiplied. The increase in frequency and volume of trading helps to enhance cryptocurrency liquidity.
Usability is another factor affecting cryptocurrency liquidity. The more cryptocurrencies are used as a medium of payment, the more liquid they become. This is why cryptocurrencies need to be accepted by merchants as a means of payment to boost the use of cryptocurrencies for transactions further.
Finally, regulations play an essential role. Different countries have adopted different stances on cryptocurrencies, with them being banned in several, allowed in some, or disputed in others. Despite the situation, cryptocurrencies are growing fast, so a clear stance by the authorities on issues like consumer protection and taxation should result in more people getting involved, thereby affecting its liquidity.
Why is Liquidity Important in Cryptocurrency?
Liquidity is the lifeline of the crypto market. It reduces investment risk; and, importantly, helps define your exit strategy — making it easy to liquidate your holding. As a result, investors and traders prefer liquid markets.
Moreover, there are some reasons that you need to know about cryptocurrency liquidity is very necessary.
Less Susceptible to Market Manipulation
As a nascent technology, cryptocurrencies currently don’t have a defined path — it’s less regulated and contains many scrupulous players who want to manipulate the market for their benefit. However, the highly liquid nature of top-performing cryptocurrencies makes them very resistant to market manipulations — more market players (buyers and sellers) mean smooth transactions. So, it becomes more demanding for a single market player (or group of high-end players) to control the market.
Price Stability and Less Volatility
Experienced investors and speculators consider a liquid market more stable and less volatile. Why? A buoyant market with high trading activities will create equilibrium between the buyer and the seller. So whenever you’re selling or buying, there will always be several others willing to do the opposite, which will always equilibrate price and minimize fluctuation. In highly liquid markets, people can enter and exit positions without experiencing much price volatility or slippage.
Easier to analyze Trader’s Behavior
The number of market participants interested in a cryptocurrency usually determines the liquidness of a market. More participants lead to more cryptocurrency liquidity, and this would relay more information about the market. More buy and sell orders will also create a tighter spread (difference between the bid and ask price) and minimize volatility, which provides a clear picture of the previous market cycle.
Thus, sellers will sell at competitive prices in a market with lots of trading, so they don’t lose out. But buyers might come and offer higher prices because they may be a bit more desperate to be in the market. This will create an equilibrium market price that is good for everyone.
These factors help develop accurate and precise technical charts to define the behavior of traders and the direction of the market. So it would be easier for traders to analyze the market, make accurate predictions, and informed decisions.
Faster trading period
Besides the excellent user experience and convenience, liquidity is also crucial for cryptocurrency traders to maximize profit. A liquid market contains more market participants that make it easier and faster for trades execution.
During extreme market volatility, traders holding these assets find it easier to exit when the market is moving against their position and minimizes loss. In contrast, illiquid asset holders will be stuck on trade until they find an interested buyer, even if the market is against them.
Liquidity is one of the essential characteristics that investors and traders should be aware of when evaluating a cryptocurrency. It impacts both price stability and volatility, which in turn affects an asset’s ability to maintain its value over time. The more liquid a cryptocurrency is, the less volatile it will remain – even if there are periods of fluctuation, they will tend to hover around stable prices. Ideally, you want to invest in a token with high liquidity because this means that someone can easily buy from or sell to you at any given moment without affecting the price too much. The above article is GIG’s sharing about “What is cryptocurrency liquidity? How to understand the liquidity of a crypto exchange?”. Subscribe to GIG Dollar to stay up to date with the latest news on blockchain, cryptocurrency, digital asset investment, etc.
Telegram Channel: https://t.me/gigdollario