Liquidity is an important concept in the Crypto World. Understanding this aspect can help you make your trading and investment decisions more thoughtful, as well as minimize risks. This is especially important for investors who operate with big amounts of money. In this material, we will try to reveal some of the implicit features of the cryptocurrency market, find out what liquidity is and how to work with it while trading.
What is liquidity?
Liquidity shows how easy and fast it is to buy or sell a cryptocurrency at the current price. It is an important indicator – if the market is not liquid, then it can lead to extremely high price volatility and a decrease in interest around some asset.
Liquidity is mainly determined by the filling of the amount of limit orders in the order book and the value of the spread in it. Trading volume, popularity of an asset, number of large holders — everything plays a big role in making crypto more liquid.
In the cryptocurrency market, the highest liquidity can be found on the top exchanges. The more popular the crypto exchange, the more liquidity is there and vice versa. If you work with big volumes, then you might consider using several top crypto exchanges and assets with good liquidity.
What affects liquidity?
- Popularity of an asset. If the market is large and full of buyers or sellers, it'll be much easier to find somebody who's ready to purchase or sell an asset. This is affected by the popularity of the asset, which is caused by certain information events, marketing, as well as the availability of infrastructure, such as in the Ethereum DeFi sector and NFT.
- The number of transactions. If the number of transactions is greater, then it is easier for buyers and sellers to find each other and make a deal.
- Asset quality and projects roadmap. If the project is constantly developing, upgrading and has a clear goal, then buyers and sellers will be more willing to participate in it, which increases liquidity.
- Market structure and balance between buyers and sellers. If the market structure is efficient, it will be easier for buyers and sellers to find each other and make deals. As you know, order books consist of limit orders, and crypto exchanges help in every possible way to create liquidity. Commissions for limit orders are often 2 times lower than market orders. Often exchanges also cooperate with market makers who provide liquidity.
How to use knowledge about liquidity in crypto trading
There is a very simple logic, just look at the table below:
High liquidity = low volatility, low risks and stability
Low liquidity means high volatility, high risk and more opportunities to get a big profit or loss
The very choice of an asset with certain liquidity indicators, introduces certain features in terms of expectations and risks.
For example, a liquid BTC asset can lose 20% in price in one day, while a medium-liquid asset can lose 40-50% in price, and a low-liquid one — 90% or even fall to 0. The inverse proportion is also fair: BTC recovered from the lows of 2020 to the highs of 2021 with almost 1500% increase, and some medium-liquid assets might show an even bigger increase.
Conclusion
It is important to track presence or absence of liquidity in assets, even at the analysis stage. An incorrect understanding of this indicator can lead to significant losses in trading or investment. Different amounts of asset liquidity can be used to your advantage, depending on your initial data, such as the amount of the deposit and time planning.
If you want to learn more interesting facts about crypto then don’t forget to check out our blog! You might like our articles “What Is a Zero-Day Exploit” and “Top 5 Crypto Trading Strategies”.
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SimpleSwap reminds you that this article is provided for informational purposes only and does not provide investment advice. All purchases and cryptocurrency investments are your own responsibility.
