As the crypto world keeps on evolving, more and more traders are flocking toward the market in the hope of gaining a chunk of profit. Trump’s victory and BTC crossing the $100K mark have been like adding fuel to a raging fire. Following these events, the number of people who have entered the crypto market has ranged in millions in just the last 2 months.
However, most of them have faced problems in selling their token when it is rising due to liquidity issues, which resulted in significant capital losses on their part. That’s why in this article, we will look into what liquidity is, why it is essential in the crypto market, and the various factors that can have an impact on a coin’s liquidity.
What is Liquidity in the Crypto Market?
Liquidity in the crypto market is the ease by which a coin can be converted to another crypto or fiat currency without any major impact on its price and vice versa. In other words, it is a ratio of the number of sellers and buyers, and how you can easily complete your transactions in the market. Crypto assets that are extremely hard to sell or exchange are considered illiquid assets, while those that can be traded easily like BTC and ETH are considered liquid assets.
Liquid markets are characterized as the ones where the users can conduct easy, swift, and fair trade. The assets in these markets have both high supply and demand based on this supply, making it easier for its users to find potential buyers. On the other hand, there are also illiquid markets, which are represented by high volatility. Here, the investors have to struggle to find a potential buyer making it extremely difficult to conduct trade.
In simple terms, a liquid crypto market occurs when someone sells a token or asset that you wish to buy, and if you’re selling an asset, someone will be looking to buy it. It means that you can easily sell these tokens to make a profit and in the worst-case scenario, you can easily cut your losses and save your remaining capital.
Importance of Liquidity in the Crypto Market
Liquidity is one of the major factors that allows the crypto market to function effectively. The entire crypto market is dependent on the liquidity factor. Not only does it lower the investment risk, but it also prevents whales from performing a pump-and-dump scheme during a major listing event, which can significantly boost a coin’s price for a limited time frame. Other key benefits of liquidity involve
1. Prevent Market Manipulation
Liquidity can help in preventing market manipulation to a great extent. As a blooming sector, there is a lack of regulations when it comes to the crypto market. And some people like to take advantage of this to rip off money from other investors and traders. However, in the case of liquid assets like BTC and ETH, this is not possible, as one person can’t control the price action of these coins.
2. Helps in Analyzing the Trading Behaviour of Investors
The number of buyers and sellers interested in a cryptocurrency is what determines its liquidity. If more people are interested in an asset, that token is more likely to possess increased liquidity compared to others. A large number of buyers and sellers can result in a reduced liquidity state, which can help traders analyze the market and come up with logical decisions that favor them.
3. Offers Stability & Less Volatility to a Coin
A liquid market is a more stable and less volatile marketplace where trading activities like buying and selling assets go in harmony. As a result of this, people can easily enter and exit a trade causing little to no price fluctuation in the market.
Factors Influencing Liquidity In The Crypto Market
Many factors can directly and indirectly affect the liquidity of the crypto market. Here, we will look into a few of these factors, so you can understand exactly what you’re dealing with.
- Market Sentiment: Public reception and investor sentiment can greatly influence the liquidity of a crypto asset.
- Adoption Rate: The adoption of a cryptocurrency by users and other financial institutions can significantly improve its liquidity.
- Regulations: In a crypto-friendly environment, the liquidation associated with tokens is generally high facilitating easy trade.
- Trading Volume: The trading volume of a coin is a clear indicator of its liquidity. The higher the trading volume is, the more liquid the coin will likely be.
- Technological Advancements: Innovations in a crypto project can boost its efficiency, security, and even the user experience surrounding the platform. This can attract investors thereby pumping the liquidity of that particular coin.
Main Difference Between High Liquidity and Low Liquidity State
| Properties | High Liquidity | Low Liquidity |
|---|---|---|
| Price Impact | Can execute large trades without affecting the asset’s price | This can lead to a substantial change in the asset’s market value during large trades |
| Trading Speed | Trades are executed fast | Trades are executed slowly as there is a lack of demand |
| Market Volatility | Lower market volatility | Higher market volatility can cause rapid price swings |
| Trading Volume | Higher trading volume | Lower trading volume |
| Associated Risks | Less risky compared to a low liquidity state | High Risk |
Final Remarks
In essence, liquidity plays an important role in the crypto market. Without it, the crypto market will be in turmoil and collapse shortly. Every function of the crypto market ranging from the market value of an asset to the execution speed of a trade all depends on the liquidity factor. It also allows traders to execute a large trade without posing any problem. You can also employ different strategies like scalping and algorithmic trading in high-liquidity markets to boost your portfolio. For further information and updates surrounding the crypto market, stay tuned.
