In simple words, liquidity refers to the ease at which assets can be converted into cash. An asset is said to be liquid if it is easy to buy and sell. There are notably two types of liquidity, which are market liquidity and asset liquidity.
Market liquidity refers to a market’s feature where an individual can quickly purchase or sell an asset without causing a drastic change in the asset’s price. Thus, a liquid market is a market that has a lot of trading activity.
Asset liquidity refers to an asset that can be quickly sold or bought in any market such as a cryptocurrency that can be easily converted into cash or another crypto asset.
Liquidity in Cryptocurrency
In cryptocurrency, two major factors that will determine the market’s liquidity are trade volume and exchange platforms. In trade volumes, notably, a higher number of trading activity indicates higher liquidity. On the other hand, the liquidity of one cryptocurrency exchange platform is determined by supporting major cryptocurrencies, providing multiple crypto-to-crypto trading pairs and whether there is a fiat-to-crypto ramp on.
In addition to that, other factors that will lead to higher liquidity in cryptocurrency are acceptance and regulations. The acceptance of cryptocurrencies by merchants and businesses as a mode of payment will increase the usability and utility of cryptocurrencies as a viable medium for transactions. This will eventually lead to high liquidity.
Other than that, the laws and regulations of different countries can also impact cryptocurrency liquidity. Which means, with lesser restrictive regulations in relating to cryptocurrency usage, the higher the liquidity of a cryptocurrency is in the country.
Why Liquidity is Important
It is important for the cryptocurrency market and exchange platforms to have high liquidity. This is to ensure the stability of price that eventually leads to the advantage of the crypto community in general.
In a liquid market, the price will be stable and fair for everyone. For instance, a marketplace with a high number of trading activity will allow sellers to sell at a competitive price while buyer to bid at a higher price, leading to an equilibrium market price.
Illiquid markets are prone to price manipulation and a large swing in the market price due to low trading activity. This will eventually lead to high volatility and risks of the crypto community in general. On the other hand, a liquid market will not easily be affected by a single transaction and a large swing of the market price is unlikely to happen due to a high number of trades and demands.
Shorter transaction time is achievable with a liquid market. Notably, given a large number of market participants, buy and sell transactions are verified and completed a lot quicker. A liquid market will simplify and accelerate trading activity.
In conclusion, liquidity of market and assets in cryptocurrency is crucial. The higher the liquidity, the better it is for the participants and exchange platforms in general.
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Nurul is an English Language graduate who is highly passionate on writing, she literally breathes on it. An avid reader and a critical thinker, she covers on blockchain news during day and weeps at sad novels at night.