What Is The Importance Of Liquidity In Cryptocurrency?
Liquidity is a common term in the crypto market. It can denote the ease of converting one crypto asset to another or exchanging it with fiat currencies. Liquidity can also be considered as a measurement that shows how easily and quickly an asset can be sold or bought.
Cryptocurrencies are experiencing a rise in their global adoption and analysts expect an increase in the number of crypto owners in the coming years. The growth in the crypto projects making profits is also a factor contributing to the fierce rise in the crypto market. However, it is not to be forgotten that all crypto projects have not succeeded. Liquidity is blamed to the cause of the decline of various crypto projects.
Liquidity is mostly measured in volume, which shows the number of coins sold and bought per day. If the trading is in high volume, it is understood that the transactions are taking place quickly and easily.
How is liquidity important?
Liquidity is crucial for a cryptocurrency as it allows you to find the assets that allow you to make profits and sell them in return for fiat money. If the crypto asset has high liquidity, you can easily buy it or sell it close to its current value without much difficulty. Such crypto assets can be identified considering their high trade volumes and large investor numbers.
Crypto exchanges and assets with bad or low liquidity cannot be sold or bought quickly and easily. If you have crypto assets with low liquidity, the number of investors who hold the asset will be fewer, asking you more time to buy or sell them.
Market stability is also an important aspect of liquidity. More liquidity the project has, the more stable it will be because the number of sellers and buyers will be large in the market. A single trade will not bring much impact on the asset’s price.
Crypto assets that feature low liquidity will be more volatile in their prices and the market makers can easily manipulate this price. For example, if a market maker in the crypto sector is holding more than 50% of a project’s reserve, he/she can be influential in inflating the prices by storing the assets or by charging more price than their value.
The transaction time can also be reduced by trading a crypto asset of high liquidity. As the number of sellers and buyers simultaneously trading in the market is higher, it is quite easy to find a buyer or a seller. Therefore, it is better to avoid trading or buying crypto assets with lesser popularity and liquidity. However, the situation might fetch benefits for arbitrage traders.
How to measure liquidity?
The liquidity of crypto exchanges and assets is mostly measured in two methods. The common method is by calculating the total number of crypto coins traded in one market in a given timeframe. Mostly, the timeframe will be 24 hours. The higher number of coins denote the high liquidity of the asset. The next method is the bid-ask spread to find the liquidity of crypto exchanges. The lower the bid-ask spread, the higher will be the liquidity.