What is Liquidity?

For any investment, one of the most important considerations is the ability to efficiently buy or sell assets. After all, what is the point of profit if the seller is not able to realize their gains? The asset liquidity will largely determine if and how much of a position an investor can take in the investment. Of course, this extends to Bitcoin and other cryptocurrencies.

What is Liquidity
What is Liquidity? Image by pch.vector on Freepik

Liquidity in cryptocurrency means the ease with which a digital currency or token can be converted to another digital asset or cash without impacting the price and vice-versa. Liquidity is a measure of the outside demand and supply of an asset. Meaning, a deep market with ample liquidity is an indication of a healthy market. Additionally, the more liquidity available in a cryptocurrency, the more stable and less volatile that asset should be.

In other words, a liquid cryptocurrency market exists when someone is prepared to buy when you are looking to sell. If you’re buying, someone is willing to sell. It means you may buy that digital asset in the quantity that you want, take profit from a trading opportunity, or in the worst case, cut your losses should the value of the asset fall below your costs, all without moving the market dramatically.

An example of liquidity: You may have tons of bottled water available for sale, but if you’re alone in a remote desert, it will be difficult to find a buyer.

How to know if an asset is liquid or illiquid?

A liquid asset can be converted into cash quickly without affecting the price. Conversely, an asset can be considered illiquid if it can’t be bought or sold quickly. Or, if it can, the transaction would have a significant effect on its price. For example, Cash can be considered the most liquid asset since it can be easily converted into other assets; but a house is not because it takes more time to negotiate its price with a buyer or seller.

Surely, the water will be hotcakes if you’re in a desert full of thirsty tourists.

Importance of Liquidity in Cryptocurrency

The cryptocurrency market is dependent on liquidity. Liquidity in cryptocurrency lowers investment risk and, more crucially, assists in defining your exit strategy, making it simple to sell your ownership. As a result, liquid crypto markets are preferred by investors and traders.

Liquidity in cryptocurrency makes it hard to manipulate prices

Liquidity in cryptocurrency makes it less susceptible to manipulations of the market by dishonest actors or groups of actors.

As a fledgling technology, cryptocurrencies currently lack a set path; it is less regulated and contains many unscrupulous people looking to manipulate the market to their advantage. In a deep and liquid digital asset, such as Bitcoin or Ether, controlling the price action in that market becomes difficult for a single market participant or a group of participants.

Liquidity in cryptocurrency offers stability in prices and less volatility

A liquid market is considered more steady and less volatile as a thriving market with considerable trading activity can bring buy and sell market forces into harmony.

As a result, anytime you sell or purchase, there will always be market participants prepared to do the opposite. People can initiate and exit positions in highly liquid markets with little slippage or price fluctuation.

Liquidity in cryptocurrency helps in analyzing the behaviors of traders

Liquidity in cryptocurrency is determined by the number of interested buyers and sellers. Increased market participation means increased liquidity, which can be a signal of increased market data dissemination.

A larger number of both sell and buy orders reduces volatility and gives traders a comprehensive picture of market forces and can help produce more accurate and reliable technical information. Traders will be able to better analyze the market, make accurate predictions, and make well-informed decisions as a result.

Developments in cryptocurrency liquidity

We are seeing standardized futures markets pop up for Bitcoin and Ethereum. The futures markets allow investors to trade contracts, or agreements, to buy or sell cryptocurrencies at a pre-agreed later date in a developed and transparent manner.

It allows investors to not only be long or buy and hold a future claim on an asset such as Bitcoin but also sell BTC short via futures, which means they may take a negative view of Bitcoin without owning it in the first place. The market makers for these futures need to manage their own risk by buying and selling physical cryptocurrencies, thereby deepening the overall market liquidity.

Measuring Liquidity in Cryptocurrency

Liquidity, unlike other trade analysis indicators, has no fixed value. As a result, calculating the exact liquidity of the exchange or market is difficult. However, there are other signs that can be used as proxies for liquidity in cryptocurrencies.

Bid-Ask Spread

The gap between the highest bid (selling) price and the lowest ask (purchasing) price in the order book is known as the bid-ask spread. The narrower the spread, the more liquid a cryptocurrency is said to be.

If a market for a digital asset is illiquid, investors and speculators would expect to see a wider bid-ask spread, making it more expensive to transact in that digital asset.

Trading Volume

Trading volumes are an important factor in determining liquidity in the cryptocurrency market. It refers to the total amount of digital assets exchanged on a cryptocurrency exchange over a given period.

The indicator impacts the market players’ direction and behavior. A higher trade value indicates more trading activity (buying and selling), implying greater liquidity and market efficiency. Lower trade volume means less activity and low liquidity.

Market Size

At present, the size of the overall cryptocurrency market, including Bitcoin, is still quite small. For example, based on the historically high price that Bitcoin has achieved of around $68,000 USD each and roughly 19 million or so BTC mined, its total market capitalization is around $1.3 trillion, where market capitalization is calculated as the amount of an asset outstanding multiplied by the price of each one of that asset. Industry estimates for the total market capitalization of all cryptocurrencies in the second half of 2021 are just over $2.5 trillion USD.

While those might sound like huge amounts of money, we are far from being as large and liquid as other financial markets that professional investors would normally participate in. Let’s look at the market capitalizations of some other assets out there:

US Equity, or stocks: $40 trillion USD

US Fixed Income, or bonds: $47 trillion USD

Global Equities: $106 trillion USD

Global Fixed Income: $124 trillion USD

Gold: $12 trillion USD

What is the most liquid asset in the world of crypto?

Stablecoin will be the answer. Much of the volume in the cryptocurrency market is stablecoins which makes them very liquid.

Understanding liquidity

There are two different areas regarding liquidity: liquidity assets and liquidity market.

– A liquid asset refers to an asset that can be easily converted into cash.

– Liquid market means that there are always investors in the market willing to trade.

The relation of liquidity to cryptocurrency

Cryptocurrency prices fluctuate and rapidly change from time to time. To maximize profits, traders need to move in and out of the market quickly. Furthermore, traders should avoid price cuts or wait for too long to execute trades.

Here’s an example from a seller’s point of view: Selling 10 BTC at the current market price

– If the market is liquid, there will be enough buyers that are willing to buy bitcoins for the asking price, and the order will be fulfilled immediately. The trade will not affect the bitcoin price since there is sufficient liquidity in the market.

– If the market is illiquid or has low liquidity, then the market will not have enough buyers willing to pay the BTC asking price. In that case, the seller could lower the asking price or use limit orders to create an order to be able to sell their bitcoins. However, if the seller decides to lower the asking price to sell 10 BTC, it will also affect the current market price of bitcoin.

How to buy Bitcoin (BTC)

You can buy Bitcoin (BTC) on MEXC by following the steps:

  1. Log in to your MEXC account and click [Trade]. Click on [Spot].
  2. Search “BTC” using the search bar to see the available trading pairs. Take BTC/USDT as an example.
  3. Scroll down and go to the [Spot] box. Enter the amount of BTC you want to buy. You can choose from opening a Limit order, a Market order, or a Stop-limit order. Take Market order as an example. Click [Buy BTC] to confirm your order. You will find the purchased BTC in your Spot Wallet.

You can find a detailed guide on how to buy BTC token here.

Keep Yourself Updated With The Crypto Trend

Check out all of the listings in the Innovation and Assessment zones as well as the major tokens in the Main Zone – we have more amazing projects to come! What’s more, MEXC lists moonshots and offers access to trade major cryptocurrencies. Visit the Hot Projects section as well to uncover more featured popular tokens. Lastly, feel free to visit MEXC Academy to learn more about cryptocurrency!

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We are your first stop for high quality projects - Buy, Sell & Trade Cryptocurrencies, NFTs, Margin, ETF, Futures, DeFi!