How liquid a cryptocurrency is can further determine its faith, but what does this liquidity means? Whether you are a crypto newbie or a veteran investor, you have surely heard about the concept of liquidity at least once. So, let us clarify it all for you.
When the various exchanges in the crypto space are put in comparison, the most used term to describe this phenomenon is liquidity. Like any other factors (security and fees, for example), liquidity can significantly impact a trader's chance of getting a fair exchange rate for their virtual coins. In other words, liquidity refers to the ease by which a cryptocurrency can be converted into fiat money. Besides, it is present in any financial market out there, so crypto is not the only space where liquidity makes its presence felt.
Without further ado, here is everything you need to know about crypto liquidity:
Another term used for converting to cash is liquidating - hence the liquidity concept in crypto. Liquidity is usually described as the ease with which a cryptocurrency such as Ethereum and Bitcoin can be converted into cash or swapped for other digital assets. Simply put, liquidity establishes how easily and rapidly a cryptocurrency can be purchased or sold. The easier it is to convert something into something else, and the less likely a crypto owner is to move the price by their action, the more liquid that crypto or asset is believed to be. Cash or fiat money, for instance, is the most liquid currency of all, whereas precious metals such as silver and gold are rather illiquid, as selling them can take longer and implies heaps of fees, commissions, and papers.
Liquidity can make or break a trade, so understanding it when dealing with cryptocurrencies is vital. Usually, crypto fluidity is measured in volume, i.e., the number of coins that are purchased or sold on a daily basis. If there is a high trading volume (and, implicitly, more involvement among market participants), transactions are carried out rapidly and easily.
Liquidity is crucial as it helps investors find cryptocurrencies that can not only bring them consistent gains but can also be sold without much hassle. Highly liquid cryptocurrencies can be recognized by a significant number of investors and their high trade volumes. High market liquidity is the perfect opportunity for buyers and sellers to benefit from improved asset prices. Not to mention that a high level of trading activity inevitably results in an equilibrium market price reasonable for everyone.
Another significance of crypto liquidity is that it contributes to market stability. The higher the liquidity of a particular asset, the less likely it is to fluctuate up and down tremendously. It is essential for cryptocurrencies to be stable to weather large orders; otherwise, market makers can easily manipulate volatility and inflate prices.
Since Bitcoin is the world's largest cryptocurrency, it is normal for people to wonder whether it is liquid or illiquid. Surprisingly or not, it is one of the most liquid assets on the market, at least most of the time. Why "most of the time"? Well, because market conditions are not always the same, and prices fluctuate even in the case of such an established asset like Bitcoin. During panic buying, for example, or panic selling, Bitcoin tends to have lower liquidity levels. The same is true for any other cryptocurrency out there, including the other crypto's kings and queens - Ethereum, Tether, and XRP.
Nonetheless, investors holding vast amounts of Bitcoin, the so-called whales, can influence the crypto asset's price with their tall purchase and sell orders. One of the many reasons for this phenomenon is the variety of crypto exchanges that generates price inconsistency throughout the markets. So, transferring unbelievably vast amounts of Bitcoin may come with some slippage (the inability to purchase or sell a given asset at the market price in huge volumes), but this is hardly surprising.
Undoubtedly, if all investors used a single crypto exchange, the marketplace would certainly be more liquid.
Bitcoin is definitely a cryptocurrency worth noting, given its stable price compared with other virtual coins and high liquidity. But, when planning to invest in Bitcoin, looking for how to buy cryptocurrency is not enough; more often than not, you have to research other critical aspects regarding this crypto, including the factors that impact its liquidity.
So, here are the most significant variables that can influence Bitcoin liquidity:
• Storage. It might sound a bit unusual, but the way in which users store their cryptocurrencies can significantly impact their liquidity. The same is true with Bitcoin since it is a scarce digital property. Therefore, individuals that hold vast amounts of Bitcoin prefer to store their assets in a cold wallet, whereas less significant amounts of Bitcoin are usually kept in a hot wallet. Since cold wallets operate without a connection to the Internet, i.e., they are based on hardware storage, they are more secure. People tend to be fans of these wallets because they make their Bitcoin assets less prone to be hacked or stolen. But this inevitably takes them off the market, which results in lower liquidity.
• Volume. The amount of Bitcoin traded in a day, for example, or any given time frame is called volume. So, the higher it is the trading volume, the more increased the liquidity is.
• Volatility. Although volatility and liquidity are often confused for each other, they are by no means one and the same. Instead, they are related, as higher liquidity usually results in lower volatility. Conversely, a lack of liquidity causes higher volatility.
• Exchanges. Generally, the more crypto exchanges there are, the more markets there are for individuals to purchase and sell assets. So, if we return to the volume factor mentioned above, this makes sense. Once people have access to more marketplaces, increased liquidity of the traded crypto is possible.
Bitcoin is the most liquid cryptocurrency at this moment, followed by Ethereum, Tether, and USDT. Thence, the most-traded cryptocurrencies are also the most liquid.
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