When different exchanges in the cryptocurrency space are compared, one of the terms that get thrown around more than any other is liquidity.
While other cryptocurrency exchange attributes, such as security and fees, are also essential to consider, can have a tremendous impact on one’s ability to get a fair exchange rate for their crypto asset. But what is liquidity? Let’s take a closer look at this crucial aspect of the exchange ecosystem.
What is Liquidity?
Liquidity effectively measures the ability to buy or sell a particular asset at its current fair market value. So, for example, if you have some Bitcoin and want to trade it for U.S. dollars, there needs to be enough demand on the other side of the order for you to be able to make the sale at the current exchange rate.
If you want to sell $1 million worth of Bitcoin and there is only $500,000 worth of buy orders close to the current market rate, then you’ll end up selling some of your Bitcoin at a lower price than what is generally accepted as the current exchange rate.
Cash is generally accepted as the most liquid asset globally because it can purchase anything without slippage. However, while Bitcoin is intended to be a form of digital cash, it does not have anywhere near the levels of liquidity found in fiat currencies like the U.S. dollar.
Liquidity is a concept that is important to understand when dealing with cryptocurrencies. In terms of defining liquidity, it is essentially the ability of an asset to be quickly converted into cash.
Why is Liquidity important?
High liquidity in the marketplace is ideal as it makes for an improved price channel for all concerned due to the many buyers and sellers in the market.
High liquidity also ensures that prices are stable and not prone to large swings resulting from large trades, affecting cryptocurrency prices while fuelling increased volatility and risks for the general market. In a liquid market, prices are stable enough to withstand large orders because of many market participants and their demands.
Factors affecting Liquidity
One of the critical factors affecting liquidity in the cryptocurrency market is trading volumes. You can check out any cryptocurrency market cap rankings website to see daily books, with a higher volume indicating that more people are buying and selling coins.
Unfortunately, inadequate knowledge and clear-cut guidelines by authorities have so far limited these activities mainly to enthusiasts. Still, interest in bitcoin trading and cryptocurrency trading, in general, is attracting more and more people to get started.
A higher number of cryptocurrency exchanges provides more opportunities for more people to trade their coins, and in recent years the number of interactions has multiplied. In addition, the increase in frequency and volume of trading helps to enhance.
Usability is another factor affecting liquidity. The more cryptocurrencies are used as a medium of payment, the more liquid they become. This is why cryptocurrencies need to be accepted by merchants as a means of payment to further boost the use of cryptocurrencies for transactions.
Finally, regulations play an essential role. Different countries have adopted different stances on cryptocurrencies, with them being banned in several, allowed in some or disputed in others.
What to consider when choosing a Liquidity Provider
To source the best liquidity provider, brokers need to assess their own specific needs and address several factors:
What’s On Offer.
Primarily, a broker should look at the overall package on offer relating to what assets and the kind of liquidity being provided. The liquidity provider must provide multi-asset and access to the FIX protocol and historical data. In addition, a nominated account in different currencies should ideally be an option and the ability to accept all significant stable tokens and cryptos for depositing and withdrawal.
Pricing.
A liquidity provider’s price offering must include competitive spreads and low commissions and swaps with no compromise on either side.
Fast Executions.
A liquidity provider must offer fast trade executions with re-quotes or slippage, particularly during times of high-impact market news.
Market Depth.
Market depth is another crucial consideration. This provides an indication of the liquidity and depth of a particular currency. The higher the number of buy and sell orders at each price, the higher the market depth.
Reporting Requirements.
A liquidity provider should provide an automated and robust reporting system to comply with regulatory requirements. Typical reports include trade reports, FIX bridge reporting, swaps and rollover reporting, and order book access.
Data Feeds.
A liquidity provider should be able to offer client data feeds that are stable and reliable. Price feeds must reflect real-time prices from all relevant exchanges as well as the interbank forex market. Any delays in price data delivery may result in gaps.
Authenticity.
Liquidity providers should be regulated similarly to brokers to ensure they operate under the industry’s best practices. A prime broker is backing up the liquidity provider.
Liquidity vs. Volume
Liquidity is often conflated with volume, but these are two different things. There is usually a close relationship between liquidity and volume, but high volume does not necessarily mean high liquidity.
Trading volume is simply a measure of the value of executed trades within a period, typically measured daily. On the other hand, liquidity has more to do with the buy and sell orders currently on the order books. In other words, volume is a measurement of the trades that have already taken place, while liquidity informs the buy and sell offers that can currently be accepted on the exchange.
Is Bitcoin Considered a Liquid Asset?
In terms of the cryptocurrency market, there is no asset more liquid than Bitcoin. However, Bitcoin whales can still move the crypto asset price around with their large buy and sell orders.
This may be for various reasons, one of which is that there are hundreds of different exchanges, which creates price discrepancy throughout the markets. Instead, all cryptocurrency trades were performed on a single centralized exchange. As a result, the market would surely be more liquid.
A liquid asset is defined as an asset that can be turned into cash quickly at a rate that isn’t far off the price quoted on the open market. The nature of Bitcoin makes it so it can be turned into cash very quickly, but those transferring enormous amounts of Bitcoin may experience some slippage.
It should be noted that Bitcoin liquidity and trading volumes have increased tremendously since the early days of the technology.
