What is liquidity? Are cryptocurrencies liquid assets? How can traders and investors use the notion of liquidity to multiply their profits? Upgrade your investing skills!
Crypto liquidity: why is this index important for investors?
The number of virtual assets is dynamically on the rise. According to Coinmarketcap, the total amount of cryptocurrencies has already surpassed the mark of 7000. Meanwhile, the analyst Larry Chermak calls 90% of all virtual currencies non-liquid assets. Is this characteristic important? And what does liquidity mean in general words?
Liquidity as the basic value of an asset
Liquidity of a thing (asset) is regarded as an opportunity to sell it instantly by the market price. The easier a person can exchange a thing (asset), the more liquid it is. For instance, an enterprise’s equipment has low liquidity, as a person can hardly find a buyer, while top fiat currencies have absolute liquidity, because holders may exchange them any time. The term ‘liquidity’ refers to corporations, banks, and separated assets, including virtual currencies.
Liquidity and cryptocurrencies: how these notions are interdependent?
Crypto liquidity is an opportunity of a coin to be easily converted into fiat or other crypto assets. Low liquidity of an asset shows the market volatility leads to essential price run-ups, while high assets’ liquidity is referred to a stable market. Investors are more interested in liquid assets, as they are able to purchase and sell virtual currencies easily. Orders are about to be closed within the shortest possible time. That means a person may enter or close a deal any time, based on technical or fundamental analysis.
How to understand whether a crypto asset is liquid
Let’s illustrate the crypto liquidity by the following example. A trader holds 100 tokens of X coin, which price commences to grow. That’s obvious that a trader wishes to sell tokens to get profits. There are two ways. In case of a liquid asset, traders sell their tokens easily, without any impact on market prices. As for non-liquid assets, a trader’s sell will lead to the price drop.
Investors and traders should take into account two metrics: 24 hours trading volume and order book volumes. Note that order book volume cannot show the fair statistics due to stop-loss limits applied frequently by trading bots.
Furthermore, liquidity highly depends on the demand of a certain asset. Investors are accessible to divide the 24h trading volume by a coin’s price to get an asset’s turnover. For instance, let’s calculate the demand of some cryptocurrencies from top-50 ranking (#1, #5, #10, etc.):
Hence, the table illustrates that demand and ranking of a crypto asset are not interdependent. For instance, BitTorrent (#50) is more liquid than Wrapped Bitcoin (#30). Investors should investigate the demand changes within at least 1 month to get a full picture of crypto assets liquidity.
Factors to influence the crypto market liquidity
When an investor understands what is liquidity, the next step lies in comprehending key factors to influence this notion. The following aspects need to be taken into account:
1. Trading volume. Such a factor is among the key characteristics to help a trader understand whether the market is liquid. High trading volume shows many investors are interested in buying and selling coins. Analyze the volumes at runtime.
2. Applicability. The more applicable certain coins are, the higher their liquidity grows. For instance, Bitcoin is accepted by more than 40 million merchants globally, and this factor is interdependent with a crypto turnover. When some corporations add crypto assets to the list of payment options, such a step increases their liquidity.
3. Legislative factor. Different countries have different attitudes towards virtual assets, and the official behavior of governments influences the market as well. For instance, in some states of the USA people are free to pay taxes in crypto. The more people are involved into virtual assets on the governmental level, the more liquid cryptocurrencies become.
Why is crypto liquidity important for traders?
A trader may obtain a profound comprehension of what is the definition of liquidity, but how this knowledge can help to increase profits?
1. The risk of manipulations. Illiquid markets can be easily manipulated by major players; hence, traders are at risk to lose their assets.
2. Transaction time. The more liquid an asset is, the fewer time it requires to close an order. Such a peculiarity is of much account for scalpers and day traders.
3. Technical analysis. The instruments of technical analysis are more precise on liquid markets. Illiquid markets are rich in unexpected price movements.
How to get profit from illiquid assets?
Advantages of more liquid markets are evident, but what about assets having low liquidity? Should investors keep away from those markets? Traders face both risks and excellent opportunities. Price drops or run-ups provide a trader with chances to earn much. Furthermore, illiquid markets open perspectives for arbitrage trading.
Hence, discussions have been going on whether liquid markets are the only way for investors and traders to get profits or there are chances to be in the black, participating in illiquid markets as well.