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Liquidity in cryptocurrency explained

Liquidity in cryptocurrency is one of the least mentioned aspects in the entire crypto environment.

Although the crypto community is not talking about liquidity so much doesn’t mean that is not important.

On the contrary, liquidity is considered one of the primary metrics to look at in order to make crypto related decisions.

But, what exactly is liquidity?

Liquidity in cryptocurrency refers to the ease of a trader to convert his crypto assets into cash or another altcoin.

Low levels of liquidity in the market might provoke high volatility, delayed and even costly transactions.

With that being said, it is becoming pretty obvious to always pay attention to liquidity levels before making any decision.

Except liquidity, you are suggested to give enough attention to other cryptocurrency metrics like market cap, exchange volume, the circulating supply of each coin and others.

What is liquidity in cryptocurrency?

Liquidity is a measure of how easily a market can be exchanged. 

In essence, refers to how easily an investor can get his money out of a cryptocurrency asset.

That money could be fiat money, another crypto coin or anything else.

As a result, when liquidity is high, investors who already own cryptocurrencies are able to easily sell their crypto assets.

In fact, high liquidity means that there are enough buyers in the market who are willing to buy a crypto asset at the current price.

As you can understand, high liquidity levels are the ideal situation for the crypto market and pretty much every market.

Generally in high liquidity:

  • price fluctuations are very limited
  • traders/investors are able to buy and sell without worrying about external factors
  • The crypto prices are expected to go up because the higher levels of demand will push the prices to rise

On the other hand, there is the case of low liquidity which unfortunately brings together many downsides.

Illiquid market means that there are not enough buyers that are willing to pay for a crypto at the current price of the market.

Subsequently, the seller has those two options below:

  • To sell his assets at a lower price
  • To wait until the liquidity levels rise and then sell his digital coins

Some key takeaways for low liquidity are:

  • The more illiquid a market is, the more volatility is expected to have which involves a lot more of unnecessary risk
  • Cryptocurrency prices are expected to go down due to the absence of buyers willing to buy  

Although low liquidity levels seem very intimidating they might not be that bad because they could offer some profitable opportunities.

And that’s because when the prices go down due to low liquidity, it means that prices are at a lower level than their actual value.

So a low illiquid market is usually the best time to buy cryptocurrencies and then just wait until the market rises again.

How do you check crypto liquidity?

The first and most reliable indicator to use to see if liquidity is high or low is the trading volume.

You should click at this post which is a more comprehensive guide of what exactly is trading volume and how exactly it helps us make better decisions.

In general, trading or exchange volume shows the amount of money that has been traded in a specific period (usually 24 hours).

Therefore, investors should compare the exchange volume of the last few days with the average of the last year and realize whether the market is liquid or not.

Additionally you could also consult the bid-ask spread.

That spread indicates the difference between the highest price that a buyer is willing to pay for a crypto asset and the lowest price that a seller is willing to accept.

The lower the bid-ask spread is, the lower is the liquidity.

Does cryptocurrency have liquidity?

Cryptocurrency market has not yet achieved the desired level of liquidity.

Although with the pace that the popularity of cryptocurrencies rises, we only anticipate to see higher liquidity in the next few years.

Of course this doesn’t mean that the crypto market is totally illiquid.

Is just not as liquid when compared with other markets like the foreign exchange market (which is the leader in terms of liquidity), but of course is not more liquid than the real estate sector.

At this point I should mention the fact that despite liquidity not being as high as we wanted, the crypto market is still considered to be one of the most profitable markets out there.

So liquidity is a barrier that at this point we should learn to live with, or even better (if it is possible) take advantage of it.

Is Bitcoin easy to liquidate?

The answer in this question is “it depends”.

If we compare Bitcoin with other cryptocurrencies, we could say that it is the most reliable digital coin that exists.

Of course since Bitcoin belongs to the wider cryptocurrency sector means that Bitcoin itself also faces problems of liquidity when compared with assets of other markets for example the Tesla (TSLA) stock in the stock exchange market.

Conclusion

Liquidity in cryptocurrency is extremely important when deciding your trading positions and even the ability to enter or exit the game.

So investors are recommended to include the liquidity metric in the process of decision making and they can do that by looking at the trading volume and the bid-ask spread.

Finally the crypto market is not among the most liquid, but that doesn’t mean that it cannot be lucrative.

And the proof of that is the real estate market which has extremely low liquidity but is very profitable.

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