What Is Liquidity in Crypto?

What Is Liquidity in Crypto?

Liquidity in cryptocurrency markets is often used to describe the ease with which a crypto asset (like Bitcoin or Ethereum) can be swapped for other tokens or converted into fiat currencies. In simple terms liquidity shows how quickly and easily an asset can be bought or sold.

The global adoption of cryptocurrency is on the rise. Analysts predict that the number of crypto owners will reach one billion people by the end of 2022. This fierce growth of cryptocurrency is fueled by the more than 20,000 crypto projects that have been making money in crypto since Bitcoin debuted in 2009.

However, not all of these projects have survived, with liquidity being the prime reason for their deaths. In this article, you’ll learn what liquidity is and how new crypto investors can use it to avoid high-risk crypto assets.

Liquidity is an indicator of the popularity of an asset and how fast it can be bought or sold. This is typically measured in volume. Volume is how many coins are bought and sold each day. A high volume being traded means that transactions happen easily and quickly.

Importance of Liquidity

Determining the liquidity is important in crypto because it helps you identify assets you can not only make money in crypto with but also sell for a fiat. High liquidity means the crypto asset can be easily bought or sold close to its value. High liquidity crypto-assets can easily be identified by their high trade volumes and a large number of investors.

On the other hand, crypto assets and exchanges with low or bad liquidity cannot easily be bought or sold quickly. Buying cryptos with low liquidity would take more time, as few investors are holding the asset.

Another importance of liquidity is market stability. Projects with high liquidity are more stable because plenty of buyers and sellers are trading in the market. As such, the price of the asset will be less affected by a single trade.

On the contrary, the prices of crypto assets with very low liquidity are more volatile and can easily be manipulated by market makers. For example, a crypto market maker holding 50% of the reserves of a project can decide to inflate the prices by hoarding the asset or charging more than its value.

Lastly, trading a high-liquidity crypto asset reduces transaction time. Because there are plenty of people trading the market simultaneously, it becomes easy to find a seller or a buyer. Therefore, we advise against purchasing and trading obscure crypto assets with limited liquidity and popularity. However, arbitrage traders can take advantage of these situations.

How Is Crypto Liquidity Measured?

Now that you know the importance of highly liquid crypto or exchange, how do you measure their liquidity?

There are two major ways of measuring the liquidity of crypto assets and exchanges. The most common method is to calculate the coins traded in a single market during a given 24-hour period. Greater trading volume equates to more trading activity (sellers and buyers) and indicates a highly liquid market.

A 24-hour trade volume of a crypto asset is not enough to determine if it has high liquidity or not. This is because the trade volume is likely to drop during an extended bear run and rise considerably when the market is bullish.

The bid-ask spread is another method of determining the liquidity of exchanges. Exchanges that have a very low bid-ask spread are considered more liquid than those with an outrageous bid-ask spread.

Conclusion

Liquidity has become an important parameter investors pay attention to when deciding which project to invest in. It should be noted that the liquidity of cryptocurrencies isn’t a static concept andwill increase further if adoption rises. If more investors buy the asset either to trade or hold and it becomes more widely accepted as a medium of exchange, the liquidity of that crypto asset will increase over time.