In short, liquidity is the ability to make purchases and sales without causing noticeable changes in the value of goods. Simply put, it is one of the pillars of financial system “stability”.
This term can be used in relation to two important concepts — the market and assets. Liquid market allows the conditions of interaction under which there are always investors who ensure the sale and purchase of goods at set prices. Liquid assets can be quickly converted into cash or other cash forms at quoted prices.
As for cryptocurrencies, the meaning of liquidity is pretty much the same. This is an opportunity to purchase or sell the corresponding token without a long wait and at a predetermined price. This can happen only with a high level of trading activity and not too much difference between supply and demand prices.
Specific example
Sam has 5 tokens. He carefully monitors their exchange rate and sees that their market value has increased in a couple of days. Sam doesn’t want to wait and decides to sell his assets.
If the market is liquid, those who wish to buy them will appear promptly, and Sam will be able to sell his tokens precisely for the amount he set. In addition, a successful transaction will not affect the overall level of supply and demand, so the price will not increase noticeably.
If the market is not liquid, Sam will either have to wait for people who want to buy his tokens based on the sale/purchase difference or reduce this very difference. And if he chooses the second option, he will slightly underestimate the general expectations of the market, which will lead to a further decrease in prices and the general level of liquidity.
Liquidity determining methods
There are several parameters that allow you to establish whether a particular cryptocurrency market is liquid.
- The trading volume for the past 24 hours should be large (trading activity);
- A clearly defined volume of the order list and the indicated amounts, which allows determining the difference between the price of supply and demand (transparency and a small difference between prices).
However, as a rule, this is far from enough. For example, because of concepts such as the stop limit of orders and the iceberg order, which automatically make sure that not all orders are displayed in the list but only those that have been completed or meet certain conditions. That is, the true trading volume may be more than visible.
In any case, liquidity is a solid guarantee that you can easily enter the cryptocurrency market and exit it just as easily, withdrawing all the invested and earned sums.