How easily a cryptocurrency can be bought and sold without impacting the overall market price.
What Is Liquidity?
In its most simple form, liquidity refers to how easy it is to convert cryptocurrency into cash quickly — and whether this can be achieved without the asset’s value suffering.
Liquidity can also be used when weighing up which exchanges enable trades between fiat and crypto to be completed instantly and without price slippage. The levels of liquidity will often depend on how many users that particular platform has.
In a perfectly competitive market, liquidity will erode the ability to charge a discounted price or a premium. This is because active trading of a cryptocurrency or any asset class helps avoid price distortions.
A cryptocurrency which is liquid typically trades around its market price.
The most liquid market in the world is the forex market. On average, it recorded $6.6 trillion in daily transactions a day as of April 2019, according to the Bank for International Settlements.
On the other hand, the real estate market is typically considered to be illiquid. This is because properties are often not easily sold, and can involve a long chain, a lot of paperwork as well as be subject to other variables.
Liquid markets are typically preferred by traders. An illiquid market makes it very difficult for participants to enter and exit positions.
Trading volumes for Bitcoin are now comfortably in the tens of billions on a daily basis, and have grown substantially since 2014.
This is not to say that the bellwether currency has never experienced bouts of illiquidity. Once BTC prices crashed in 2018, volumes plummeted to around $5 billion per day.
The liquidity of cryptocurrencies is likely to increase further if adoption rises, and virtual assets become more widely accepted as mediums of exchange.