If you’ve been dipping your toes into the world of crypto, you may have come across the term liquidity. It’s one of those words that gets thrown around a lot, especially when people talk about trading, exchanges, or market trends. But what exactly does it mean? And more importantly, why should you care?
Whether you’re investing in Bitcoin, altcoins, or are just curious about how the market works, it is essential to understand liquidity. Doing so can influence the ease with which you buy or sell crypto, the prices you get, and even your overall experience on an exchange.
This post will attempt to break it down in simple terms for you. Hopefully, it will give you a greater understanding of how you can benefit from it.
What Is Liquidity in Crypto?
In the crypto world, liquidity refers to how easily you can convert a digital asset into cash or another coin without affecting its price too much.
A highly liquid asset means there’s a lot of trading activity. Thus, you can buy or sell it quickly, with minimal price change. On the other hand, a low liquidity asset is harder to move without causing a noticeable price swing.
A good way to think of liquidity is like the fuel that keeps the crypto market running smoothly. Essentially, it’s what allows trades to happen efficiently, prices to stay stable, and users to jump in and out of positions as needed.
Why Does Liquidity Matter?
You might be asking, why does liquidity matter? Well, that is a good question. Liquidity matters in crypto for several reasons, especially if you’re looking to make savvy decisions or avoid unnecessary risks.
Here’s why it’s important:
- Faster trades: High liquidity means orders are matched quickly. Therefore, there is no waiting around.
- Better prices: Narrower bid-ask spreads mean you’re less likely to overpay or sell too cheap.
- Reduced slippage: In a liquid market, you get the price you expect. In a thin one, you might not.
- Price stability: Assets with strong liquidity tend to be less volatile.
Perhaps the main reason why liquidity matters is that when you’re buying Bitcoin from an exchange like Bitcoin.com.au, it is something you benefit from without even realising.
These platforms often have good market depth, deep order books and healthy trading volumes, which means your transaction is executed quickly and fairly close to the listed market price. That’s what good liquidity looks like in practice.
Market Depth and the Order Book
Talking of market depth, this refers to the number of buy and sell orders at different prices in the market. A deep market usually has lots of orders close to the current price, which keeps the market stable and helps limit sharp price moves.
All of this is visible in what’s called the order book on an exchange. This book shows pending buy and sell orders. So, if it is full and balanced, take that as a sign of good liquidity.
What Is a Bid-Ask Spread?
Another term you’ll come across is the bid-ask spread. This is the difference between what buyers are willing to pay (bid) and what sellers are asking for (ask). Generally speaking, the smaller the gap, the better the liquidity.
For example, if a coin has a bid of $100 and an ask of $101, that’s a tight spread. But if the bid is $90 and the ask is $110, then that is a wide spread, as it may cost you more to buy or sell that asset.
The Role of Trading Volume
Trading volume refers to how much of a particular coin is being bought and sold over a given period, and it plays an integral role within the crypto world.
Higher volumes usually signal better liquidity. It shows there’s plenty of market activity and participants are engaging with the asset regularly.
Overall, assets like Bitcoin and Ethereum generally have high trading volumes. That is why they are viewed as more liquid than smaller or newer coins.
Slippage and Liquidity Risk
If you have ever tried to buy a coin and ended up paying more than the listed price, then that is called slippage. It usually happens in markets with low liquidity or when placing large orders because the price moves as your order is filled. Therefore, it often leaves you with a worse deal than expected.
Closely tied to this is liquidity risk, which is the risk that you won’t be able to exit a position at the price you want, or worse, not at all. This is common in thinly traded coins or on smaller exchanges with less active users.
Crypto Exchange Liquidity
Not all exchanges operate on an equal footing. Indeed, some have much stronger crypto exchange liquidity than others, which means they consistently process high volumes of trades and maintain deep order books. At the same time, others may suffer from lower activity, especially during off-peak times or with less popular assets.
Before choosing an exchange, check for liquidity indicators like:
- Daily trading volume
- Order book size
- Spread between buy and sell prices
You should be aware that well-known platforms often partner with market makers to ensure liquidity, especially during low-volume periods.
Token Liquidity and Market Access
It is also worth noting that each individual coin or token has its own level of liquidity. Typically, this depends on factors like exchange listings, project popularity, community size, and institutional backing.
As a result, a coin might have strong fundamentals but still be hard to trade if it’s not listed on major platforms or lacks a user base. That’s why it’s a smart idea to fully assess token liquidity before diving in.
