Crypto Trading 101: Liquidity in Cryptocurrency, Explained

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In any type of investment, it is important to consider choosing an exchange that allows you to efficiently buy and sell assets. After all, a buyer or a seller realizes their gains early on and would want to easily acquire it.

More so, the liquidity of a crypto asset will also determine how much the investor will accrue in the investment and how it will position him in the market. 

What is liquidity?

To note, liquidity refers to the ease of a digital currency or token to be converted to another digital asset or fiat currency, without impacting the price and vice-versa. Liquidity measures the outside demand and supply of an asset. For this reason, an asset with ample liquidity indicates a healthy market. In addition, one can determine that the more liquidity is available in a certain cryptocurrency or digital asset, the more stable and less volatile it should be. 

Simply put, a ‘liquid cryptocurrency market’ exists if an investor is prepared to buy or a seller is willing to sell. 

Suffice it to say, liquidity on a cryptocurrency reduces the investment risk and aids the development of an exit strategy; hence, making it easy for investors to sell holdings. As a liquid market enables price stability and decreased volatility, this fact also assists in the accurate analysis of trader activity.

Importance of Liquidity 

1. Liquidity makes it hard for whales to manipulate prices. Liquidity in cryptocurrency makes the asset less vulnerable and susceptible to market manipulation by scheming actors or groups of actors.

2. A liquid market is considered thriving, with considerable trading activity. As a result, market participants like buyers and sellers are more likely to interact actively.

3. Liquidity in cryptocurrency helps in analyzing the behaviors of investors and traders in the sense that it determines the number of interested buyers and sellers of the asset. Increased liquidity can be a signal of increased market data dissemination.

How To Measure Liquidity In Cryptocurrency

Unlike other trade analysis indicators, liquidity has no fixed value, thereby making calculations for the exact liquidity of a market or exchange, difficult. Nonetheless, there are other signs or ways to measure liquidity in cryptocurrencies.

1. Bid-Ask Spread

If a market is liquid, the gap between the highest bid (selling price) and the lowest ask (purchasing price) is narrow. 

2. Trading Volume

Trading volume plays an important role in determining the liquidity of the crypto market. Trading volume refers to the total number of digital currencies exchanged on a crypto exchange over a specific period. The higher the trading volume (buy and sell activity), the greater the liquidity and market efficiency.

3. Market Size

According to CoinMarketCap, the global crypto market cap currently is  $859.01B with around 21,991 cryptocurrencies circulating in the market. While this might look like a high number, comparing this to other market capitalizations, it’s still relatively low. 

However, with how the crypto market is continuously thriving and high trading volumes on each cryptocurrency right now, the total global crypto market cap still has a high potential to increase.

Closing Thoughts

Liquidity is important when considering the state of financial markets. Ultimately, it’s crucial to consider trading in crypto assets with high liquidity since this promotes ease of entry and exit positions.

Disclaimer: This article solely expresses the author’s thoughts, which may not reflect those of Enifex. Nothing in this article should be interpreted as investment guidance. Enifex encourages all clients to do their own research before investing in cryptocurrencies.