Liquidity is one of the terms we hear all the time in the cryptocurrency world. Whether we’re talking about crypto or equities markets, the word means the same thing. While you may have a vague understanding of liquidity, do you really know what’s going on? What actually makes something “liquid”? And how do I make sure I have liquidity in my investments? If those are questions you ask yourself, then this is the explanation for you! Keep reading as we cover the topic of liquidity in simple, easy-to-understand terms.
What is ‘Liquidity’?
First things first: what does the word mean? The definition from Investopedia is simply:
“The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price.”
So what does that mean? Luckily, the definition is pretty clear and not full of technical jargon. When talking about liquidity in the markets, there are two factors we look at: the speed at which we can buy and sell, and the market price as affected by the sale or purchase.
Buying and Selling A Cryptocurrency
The first thing to consider is the speed of buying or selling at the given market rate. When determining liquidity, we need to know how long it will take us to sell a given cryptocurrency. It’s important to note that we’re talking about at the current market price.
For example, if we’re talking about bitcoin (BTC), we’re looking at how long it will take to sell BTC at the current price of $6,177.00. What we’re not going to count is how long it would take to sell at a higher price. If we decide to go set a limit-sell at $10,000, then it’s going to take longer.
The reason it will take so much longer at $10,000 though is not because there isn’t liquidity in the markets. Instead, that’s simply because we’ve placed our sell order at a substantial markup compared to the current rate. We’re effectively acting as “market makers.”
If we were to hop on to Coinbase Pro/GDAX and select “market sell,” it’s likely to only take a few seconds for the order to go through. That’s because bitcoin (BTC) has high liquidity. If we are looking to buy or sell bitcoin (BTC) at the market rate, let’s say a small amount like 0.25-.05 BTC (still $2,000-$3,000), the trade would go through in a matter of minutes.
Affecting the Asset’s Price
The second thing to consider is how our purchasing or selling will affect the market price of the cryptocurrency. For something with high liquidity like bitcoin (BTC), we’re able to buy or sell a lot without really affecting the price. With all the volume for the world’s top cryptocurrency by market cap, it should come as no surprise that most of us don’t have enough in our trading accounts to drastically affect the price of bitcoin when we buy or sell.
However, some assets (both crypto and non-crypto) don’t have that luxury. When we think about “whales” in the marketplace, for example, these holders have a significant portion of the overall coin supply for a particular coin. In some instances, large buys and large sells from just one party can greatly affect the price of the asset.
One of the biggest predictors of liquidity is trading volume. Trading volume refers to how much people have been trading a particular asset. To use bitcoin as our example again, we see that it has the highest trading volume according to CoinMarketCap. After bitcoin is ether (ETH). Both of these two cryptocurrencies have incredibly high volume and liquidity. That means that traders and investors can plan both entry and exit strategies that are unlikely to affect the price of the asset itself. If you buy $200 worth of BTC or ETH, the price isn’t going to shoot up simply because you purchased it.
Low Liquidity Assets
Okay, so that makes sense…but then what’s on the opposite side of the spectrum? Sure, BTC and ETH don’t move a lot when I personally buy and sell, but there are others that do, right?
There are some cryptocurrencies and other assets out there with very low liquidity. If we go to CoinMarketCap and start looking at purchasing very small market cap coins, we’ll see right away what that looks like. After scrolling to the very bottom of the market cap list, we’ve found Shopin (SHOP) token. Here’s what the chart looks like:
As we can see, the trading volume is pitifully low and the there aren’t even numbers available on global volume or market cap. When looking at the chart, we see sections that look like large, block cutouts for the pricing. When someone decided to invest into the project, the very act of purchasing more tokens significantly raised the price. Likewise, selling tokens meant a resulting decrease in the price as well.
Other Low Liquid Assets
Besides the world of cryptocurrencies, there are many other assets that have low liquidity too. Two of the most obvious examples are real estate and artwork. Every time property is is going up for sale, the process isn’t as simple as buying a soda at the gas station. Instead, it can take extended periods of time to find buyers and actually complete the sale. Artwork is in a similar boat. Most art dealers and collectors can’t simply walk into a shop and ask for $____ for a painting and expect to be paid right then and there.
Hopefully that’s given you a little better understanding of how liquidity works and what it means when traders are discussing it. If you’re looking for a quick, easy exit strategy, then high liquidity is your friend. But if you’re investing early on in a small project, expect to have your funds a little less accessible for a while until volume and liquidity increases.