If different exchanges within the cryptocurrency market can be compared one the terms that is tossed around the most frequently is liquidity.
While other aspects of the cryptocurrency exchange like fees and security are also important to take into consideration and consider, liquidity could have an enormous impact on the capacity to receive the most fair price for exchange of their cryptocurrency assets. What exactly is liquidity? Let’s have a look at this crucial element of the exchange ecosystem.
Liquidity is essentially a measure of the capacity to purchase or sell a specific asset at its market value. For instance, if you own a bit of Bitcoin and you want to exchange it in U.S. dollars, there should be sufficient demand to the opposite side of the transaction to be able to complete the transaction according to the rate of exchange currently.
If you’re planning to sell the value of $1 million in Bitcoin and you have only $500,000 worth worth of purchase orders that are close to the current market price and you’ll end up selling part portions of Bitcoin at a price lower than what’s commonly considered to be currently the exchange rate. In addition, your sale order will decrease the value of Bitcoin since there aren’t enough orders to buy at the suggested price.
The issue of not being able to purchase or sell an item at the market price in large amounts is known as slippage.
Cash is usually regarded for being the most liquid investment worldwide since it is able to purchase almost anything without loss. Although Bitcoin is designed to function as a type that is digital money, however it doesn’t provide the same level of liquidity as fiat currencies, such as those of U.S. dollar.
Liquidity Vs. Volume
The term “liquidity” is frequently used to refer to volume, but they are two distinct terms. There is often a strong relationship between volume and liquidity but the volume of a large amount does not always indicate high liquidity.
Trading volume is merely an indication of the amount of transactions that are executed over an amount of time usually measured on the basis of a daily basis. Liquidity on the other side, has more to relate to the buy and sell offers which are currently on order books.
In other words, the volume is a measure of the transactions which have already occurred and liquidity is a determinant of the sell and buy deals that are currently accepted on exchanges.
Why Does A Higher Volume Of Trading Mean More Liquidity?
There isn’t an immediate connection between liquidity and trading volume but an exchange that has high trading volumes is likely to draw more traders.
There are intense network effects that are in the helm when it comes to crypto exchanges as everyone is looking to join the exchange that has the highest liquidity (due because of the massive volume of trading).
The high volume of trading could draw new buyers to the crypto exchange that could result in an increase in the number of buy and sell transactions in the books in all times and a higher amount of liquidity.
This can have a multiplier result, since higher volumes as well as more users usually implies that the exchange will provide higher rates and lower fees which will boost their in comparison to other exchanges.
Is Bitcoin Considered To Be A Liquid Asset?
In the context of the market for cryptocurrency there isn’t any asset that is more flexible than Bitcoin. But, Bitcoin whales are still in a position to shift the price of their crypto asset by putting out large purchase and sale orders. It could be for various reasons.
One reason is the fact that there are hundreds of exchanges and this causes pricing differences across markets. If all cryptocurrency transactions were executed via a single, centralised exchange it would be more fluid.
A liquid asset can be identified as one which can be converted into cash in a short time at a cost that’s not too far from the prices that is available on the market. Its nature Bitcoin is that it is able to be transformed into cash in a short time however, those who transfer huge quantities of Bitcoin could experience some slipping.
It is worth noting that the liquidity of Bitcoin and trading volumes have grown significantly since the inception of this technology. Other assets that are highly liquid include USDT which is basically a peg for cash and the Ripple which is widely used by financial institutions and banks.
Exchange Liquidity Vs. Cryptocurrency Liquidity
The distinction between liquidity of exchanges and liquidity of cryptocurrency depends on the type of asset being assessed. When you’re measuring an exchange it’s the amount of a specific crypto asset you are able to sell on the exchange, without experiencing significant fluctuations.
If you are assessing a particular cryptocurrency’s liquidity, you’ll need to consider every one of the possible ways that the cryptocurrency could be used to create cash or other types of assets.
When assessing liquidity in cryptocurrency, you’ll need to examine orders books for all the exchanges on which that asset is traded as well as other variables like how much acceptance is given to the cryptocurrency asset through payment processors.
What Cryptocurrency Exchanges Have The Most Liquidity?
The exchanges that have the greatest liquidity are the ones that have the largest trading volumes. Today, Binance has the largest Bitcoin activity through the BTCUSDT trading pair. It is also the principal trading hub for a huge amount of altcoins.
If you’re considering trading an altcoin in particular, it is important to ensure you’re focusing on the trading volume and liquidity of this particular crypto asset, instead of all the cryptocurrency tokens traded on the exchange. The smaller altcoins are usually traded on exchanges that specialize in trading.
It is important to note it is also over-the counter brokers that assist those who are looking to trade large amounts of cryptocurrency, while limiting slippage.
Stock Market Liquidity vs. Cryptocurrency Exchange Liquidity
There is no difference in how liquidity functions on a stock exchange or on a cryptocurrency exchange. The same principles apply to both.
But, there’s an important difference in the method of liquidity working for cryptocurrencies and stocks more broadly. The liquidity of stocks is centralised through an exchange. As an example, all trades of Apple stock happen through an exchange called the Nasdaq exchange.
With cryptocurrency like Bitcoin liquidity is distributed across a variety of different exchanges. As previously mentioned the effects of network effect tend to drive most traders to the same exchanges.