Published in · 7 min read · Apr 6, 2022
Liquidity is the proportion of how effectively you can change over a resource into cash or another resource. You might have some Rare Art or Bored Ape NFTs in your backpack, yet assuming you’re distant from everyone else on a far off island, observing a buyer will be troublesome.
Then again, on the off chance that you might want to purchase $100 USD of BTC on the BTC/USDT pair, you’ll have the option to do it in a flash with practically no effect on cost. For this reason liquidity is significant with regards to monetary resources.
You may have heard the term ‘liquidity’ tossed around quite a bit when discussing cryptocurrencies. But what is liquidity, and why does it matter?
In this article, we will be addressing these questions and more. We’ll explore the concept of liquidity in cryptocurrencies and its relevance to both investors and traders. We’ll also look at the factors that influence liquidity, and discuss how to determine a cryptocurrency’s liquidity.
In the traditional financial markets, liquidity is the ability to easily buy or sell a financial asset. This is usually due to a large number of buyers or sellers, large volumes of trading, or a combination of both. If you wanted to buy or sell large volumes of assets in a short period of time, you would likely choose a higher liquidity market.
If you had a choice between buying a cash-settled contract for an asset that had low liquidity and selling that same asset immediately with no market IDs, you would likely choose the latter.
Liquidity is an important factor for both investors and traders. For investors, it is a measure of how close an asset is to being a true ‘risk-free investment’. In other words, if you put your money into a Treasury bill (which has near zero liquidity) or a money market fund (with even less liquidity), you are likely taking on a great deal of risk if you want to get your money back quickly. On the other hand, a liquid asset like a stock has a very low level of risk, as your purchase will likely be quickly and easily sold should you need to liquidate your position.
For traders, liquidity is critical as it determines how quickly they can get their buy and sell orders filled. If a cryptocurrency has low liquidity, it could lead to delays in executing trades. Delays in trading could lead to losses, so it is in the best interest of both traders and investors to determine a cryptocurrency’s liquidity.
The easiest way to determine a cryptocurrency’s liquidity is to look at its trading volume. While this isn’t the only factor that determines liquidity, it is a good indicator. Generally speaking, a cryptocurrency with low trading volume is considered to have less liquidity. There are also a few other metrics you can use to determine a cryptocurrency’s liquidity.
% of 24-hour trading volume : The higher the percentage, the more liquidity a cryptocurrency has. If a coin has 100% daily trading volume, then it is in high demand and likely has good liquidity.
: The higher the percentage, the more liquidity a cryptocurrency has. If a coin has 100% daily trading volume, then it is in high demand and likely has good liquidity. Trading Fee Percentage : The trading fee percentage is the percentage of trading volume that funds are taken from investors’ accounts to pay the trading fee. If a coin has a 0% trading fee, then it is likely being traded without any funding from investors’ accounts, which means there will be no trading fee income. However, this can also be a negative if the trading volume is low.
: The trading fee percentage is the percentage of trading volume that funds are taken from investors’ accounts to pay the trading fee. If a coin has a 0% trading fee, then it is likely being traded without any funding from investors’ accounts, which means there will be no trading fee income. However, this can also be a negative if the trading volume is low. Liquidity % of Network Value : The last metric we’ll discuss is the liquidity percentage of the network value. This is calculated by dividing the daily trading volume by the network value of the token. If a coin has a low liquidity percentage, then it is likely being held by a small percentage of investors. However, this can also be a positive if the coin has a niche use case and is held by a smaller group of people who are actively using it.
There are a few factors that can influence liquidity and how easily a cryptocurrency can be bought or sold. These include the asset’s market capitalization (MC), trade volume, and supply & demand dynamics.
Supply & Demand: Regardless of the liquidity of an asset, if there isn’t enough demand to fill the supply, then it will remain relatively stagnant. For example, Ethereum has a relatively low liquidity rating compared to other cryptocurrencies, yet there isn’t nearly as much demand for it as there is for Bitcoin. As a result, Ethereum stays relatively stable in terms of price, yet has low liquidity.
Regardless of the liquidity of an asset, if there isn’t enough demand to fill the supply, then it will remain relatively stagnant. For example, Ethereum has a relatively low liquidity rating compared to other cryptocurrencies, yet there isn’t nearly as much demand for it as there is for Bitcoin. As a result, Ethereum stays relatively stable in terms of price, yet has low liquidity. Network Utility: Network utility is the amount of traffic a cryptocurrency generates compared to the amount of traffic it consumes. If a cryptocurrency consumes a large amount of electricity but has low liquidity, then it is generating almost no volume. As a result, it has low network utility and will remain relatively stable in terms of price.
Network utility is the amount of traffic a cryptocurrency generates compared to the amount of traffic it consumes. If a cryptocurrency consumes a large amount of electricity but has low liquidity, then it is generating almost no volume. As a result, it has low network utility and will remain relatively stable in terms of price. Market Capitalization (MC): The market capitalization of a cryptocurrency is the total value of all the coins in circulation. One of the factors that can influence a cryptocurrency’s liquidity is its market capitalization. A large market capitalization generally indicates having more liquidity. However, there are exceptions to this rule. For example, NEO has a higher market capitalization than both Ethereum and Bitcoin, yet it has lower liquidity.
Now that we’ve discussed what liquidity is and why it matters, let’s take a look at three different metrics you can use to measure a cryptocurrency’s liquidity.
Trading volume — This is calculated by multiplying the number of coins traded in a given period of time by the price of each trade. For example, if 1,000 people buy and sell tokens in a day, then the trading volume for that day is 1,000 x (the price of the tokens) / (the total number of tokens in existence). The higher the trading volume, the more liquidity the coin has.
This is calculated by multiplying the number of coins traded in a given period of time by the price of each trade. For example, if 1,000 people buy and sell tokens in a day, then the trading volume for that day is 1,000 x (the price of the tokens) / (the total number of tokens in existence). The higher the trading volume, the more liquidity the coin will have. Number of trades — The number of trades metric is similar to trading volume, but instead measures the number of times a coin has been traded hands. For example, if a coin has been traded 5 times in the last day, then that would be counted as 5 trades. The more times a coin gets traded, the more liquidity it will have.
The number of trades metric is similar to trading volume, but instead measures the number of times a coin has been traded hands. For example, if a coin has been traded 5 times in the last day, then that would be counted as 5 trades. The more times a coin gets traded, the more liquidity it has. Order book depth — This is the difference between buy and sell orders, and is a good indicator of how much liquidity a cryptocurrency has. If there is a large difference between the amount of buy and sell orders, it is likely that there is high demand for the coin and low supply, which will lead to more depreciation as people attempt to exit
Conclusion
Liquidity is a significant variable while thinking about the monetary business sectors. By and large, it’s alluring to exchange showcases that have high liquidity since you’ll have the option to enter and leave positions without any difficulty.
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