Every investor looks for the asset they’ve purchased to be quickly sold when they please. Cash is globally considered the most liquid asset, but cryptocurrency can also be liquid.
The concept of liquidity in cryptocurrency is nothing more than the ability of an asset to be bought or sold on demand. After all, this is where profit comes from. If one can’t convert digital goods into cash easily and speedily, they won’t be able to realize their gains. Liquidity, thus, plays a crucial role when it comes to investing in and trading cryptocurrencies.
It predicts the position a potential investor will take in their investment – and this goes as far as Bitcoin and altcoins. Liquidity is mainly influenced by the supply of a particular token and its outside demand, so the more liquidity available, the healthier and less volatile the market.
Usually, it’s more advantageous to buy and sell in a liquid market, as many participants are facilitating this action. Hence, when you’re looking for a particular asset, someone is prepared to purchase it. Likewise, when you’re buying, someone is ready to sell.
You’ll discover more about liquidity and what exactly it means for crypto in the following lines.
Significance of liquidity in cryptocurrency
The crypto market is somewhat dependent on liquidity, as high liquidity in the marketplace results in enhanced prices for all concerned. That’s because there’s a large number of buyers and sellers that act simultaneously and thus facilitate this process of trading virtual currency. Liquidity in cryptocurrency is essential to one’s trading strategy, as it helps determine their next move in this regard. There’s no doubt – a bouncy marketplace with abundant trading activity is universally preferred and accepted.
However, liquidity not only eases the buying and selling process; it has many more upsides, including:
1. It gives stability in prices and less volatility
As previously mentioned, there’s more price stability in a liquid market. Anytime you buy or sell, there will always be someone ready to do the opposite, and that’s how all these market forces are in complete harmony. The prices aren’t forecasted to fluctuate dramatically, as a liquid market is stable enough to weather any order, no matter its size. Participants can, thus, initiate and exit positions without being affected by high slippage or epic price fluctuations.
2. It makes it challenging to manipulate prices
There’re dishonest actors that would do everything in their power to manipulate the market. Surely, they’re influencing individuals, probably experienced traders or investors, that understand this market and take advantage of its downsides. But this kind of action benefits only them, not to mention that it’s possible to ruin novices or less knowledgeable traders.
Unfortunately, digital currency is less regulated than fiat currency, giving malicious actors the chance to manipulate it to their benefit. But it would be more challenging for these unscrupulous individuals to manoeuvre the market if prices were more stable. In a liquid cryptocurrency, such as Ether or Bitcoin, manipulating the price action in that particular market would be harder for market participants of the kind mentioned above.
3. It helps in analyzing traders’ behaviors
Cryptocurrency liquidity is mainly influenced by the number of involved buyers and sellers. Generally, higher market participation results in higher liquidity, which, in turn, signals enhanced data distribution.
As previously stated, a larger number of market participants diminishes volatility and gives traders a clearer image of market forces. At this stage, traders can examine the market better, anticipate prices accurately, and, consequently, make pertinent decisions.
Factors determining liquidity
1. Trading volume
Trading volumes play the most significant role here, directly impacting the market players’ behaviour and direction. Usually, a higher trading volume involves more buying and selling (trading activity), meaning greater market liquidity. A lower trading volume, on the other hand, implies less trading and hence lower liquidity. Bitcoin’s trading volume, for example, indicates the supply of BTC circulating in the market over the last 24 hours.
If you’ve decided to trade or invest in Bitcoin, it’s advisable to check the coin’s trading volume and further measure its liquidity. If there’s a high trading volume, expect to buy or convert BTC into fiat currency easily and rapidly. Bitcoin price USD is also critical, as it will help you determine the worth of your investment. So, ensure you take your research seriously before investing in cryptocurrency, be it Bitcoin or an altcoin.
The rate of adoption of a particular cryptocurrency can also impact its value and, implicitly, its volatility. Global adoption can imply that this asset could be used as an actual medium of exchange – this has already happened for many cryptocurrencies, including Bitcoin and Dogecoin. With increasingly more companies and e-commerce web pages embracing this payment form, there’s no doubt that cryptocurrency will have a big moment in 2023 and the years to come.
Exchanges also have their role, as the number of available exchanges can influence cryptocurrency’s liquidity. When there’re more exchanges, there’re also more opportunities for people to trade their assets for cash or other digital goods.
Bitcoin is legal tender in countries like El Salvador and the Central African Republic. Still, it’s banned or restricted in countries like China, Bangladesh, Colombia, and Indonesia. So, cryptocurrency’s introduction has some twists and turns. What does this mean for the future of virtual currencies? Well, it can impact confidence in the market and lead to price fluctuations. This factor, just like the ones mentioned above, isn’t under your control, so the best thing you can do is inform yourself well before investing in a cryptocurrency – what if it’s restricted in your area?
There’s also illiquidity – what does this mean?
Illiquid assets aren’t that convenient to trade or convert, and one of the leading causes is the expense involved in selling them. However, this doesn’t mean you can’t make profits from trading these particular cryptocurrencies but just that you have to be patient – it may take longer until you find an ideal opportunity where you can trade the coins at a proper price.