Liquidity is a market situation where assets can be bought and sold quickly without affecting the market price at the time of transaction. The other aspect of liquidity is to convert an asset into cash with quick turnaround time. The legal tender commonly known as money or cash is considered as the most significant liquid asset. The money is the most stable and easily accessible when compared to other liquid assets. It can be used for buying, selling, paying debts, giving loans, and is useful for all sorts of transactions. Hence, it is considered as the universal gauge to measure an asset’s liquidity. The common factor among all the liquid assets is that they will all have an open ground for trading. These assets are traded on legit exchange platforms with stable prices depending on the market conditions.
The transaction of non-liquid assets is a time-consuming process and is carried out privately. The time taken for the transaction categorizes how hard the non-liquid asset is. For instance, the time required to sell a car, real estate, painting, or any other non-liquid assets is different. It is dependent on several factors like the asset’s current value, availability of suitable buyers, documentation from necessary departments, and so on. Liquidity in the context of cryptocurrencies is a situation where the coins can be converted easily into cash or other coins without disrupting the current market price. The transactions are done online on a real-time basis and even a second delay can be a make or break situation for the traders. The majority of the traders prefer exchanges with higher liquidity as it provides a space for fast transactions at fair prices.
BENEFITS OF HIGH LIQUIDITY
- The state of high liquidity creates a fair environment for traders. The prices remain stable because of maximum trading participation by which traders are able to buy and sell the coins at a competitive cost. This reduces the loss of risk and traders are more likely to yield benefits.
- It prevents the traders from being vulnerable to a situation wherein the market faces severe fluctuation due to large scale trades. It is easy for anyone with a huge money backup to manipulate the prices of coins in a less liquid market or exchange. The exchanges with high liquidity withstand such activities as the prices are stable because of maximum trading participation.
- The transaction happens at a lightning speed. The trader can quickly buy and sell the coins which is a crucial factor in deciding the profit margin of the deal. It also helps in understanding the market situation by which trade analysts predict the prices of cryptocurrencies.
FACTORS AFFECTING LIQUIDITY
- The trading volume affects the liquidity and it generally refers to the number of coins traded in 24 hours on an exchange platform. It shows the number of people involved in buying and selling coins. The market performance of a particular coin can be measured by this parameter. If the trading volume is high, then the liquidity is high and vice versa.
- The increase in the number of reliable exchanges will expand the cryptocurrency market and people will get more trading opportunities. This will generate a higher trading volume and the liquidity will further increase.
- Cryptocurrencies should be used more as a medium of exchange. It has been accepted as a mode of payment by vendors across the globe, including industry giants like Amazon and PayPal. The wider acceptance will help in maintaining high liquidity at a larger scale.
- The facility of cryptocurrency ATMs is growing at a rapid pace. The Bitcoin ATMs have already attained global acceptance. The issue of debit and credits will make cryptocurrency a new alternative for payments.
- Regulation by the central authorities will play a crucial role in the future. The cryptocurrency is banned in certain countries and in some, it’s at a nascent stage. In these countries, the traders will find it hard to perform a transaction and they have to rely on peer-to-peer platforms. A positive approach by the government on basic aspects like consumer fund safety and taxation will encourage more people to participate in crypto trade.
All the exchange platforms religiously function to sustain the liquidity. It’s extremely important to manage a healthy trade volume and to protect the traders’ interest. Often, it is observed that coins with low liquidity are subjected to pump and dump schemes which creates hair-raising losses for small-time investors. In order to tackle such situations, the most commonly practiced method is delisting the non-liquid assets. Efforts are made to reduce the cost of switching by providing multiple trading options within a single platform. The provision to convert token-to-token through smart contracts is another method. Exchanges put several methods in practice from time to time, which depends on the magnitude of the problem. For instance, CoinDCX, India’s largest & safest cryptocurrency exchange has created a massive liquidity pool from World’s best Cryptocurrency exchanges like Binance, Huobi, and HitBTC.