Just imagine a scenario where you are carefully looking on the price charts of Bitcoin on your front runner exchange. After a few hours, you realised that all the indicators are signalling that prices of Bitcoin will fall in hours, so being a brainy crypto trader,you decided to sell your Bitcoins. But at the time of trading, you realised that your BTC selling price is much lower than you had noticed on the exchange. Finally, you ended up with a worse price than you thought! This is one of the most common conditions in crypto markets, known as liquidity of bitcoin, which can impact your returns while trading. Let us dig a little deeper to know about the liquidity in crypto space and how it affects the crypto traders.
What does Liquidity Of Bitcoin Mean?
“Liquidity” flowed from chemistry to physics to financial markets and finds the parallel meanings in every field. Nonetheless, the concept of liquidity is important in the development of crypto currency markets. In simple words, liquidity of bitcoin means the degree to which a bitcoin can be instantly brought or sold without changing the normal stability of its price. It is the ability of assets to get converted into cash(standard gauge of liquidity) readily. You have the vague idea of the answer to- “What does liquidity of bitcoin mean?”.Let us move forward.
In crypto markets, liquidity is defined at three levels:
Asset liquidity which depends on buyers and sellers and ease of accessibility of exchanges; exchange liquidity is caused by makers and takers on the platform and also by the asset pairs listed on the exchange and market liquidity is the result of all the constituents of that could affect the degree of asset to be converted to cash. Thereby, exchange and asset liquidity must be kept in mind while crypto trading.
Why Is Liquidity Important In Crypto Space?
Theoretically, we came to know about the meaning of liquidity but what does it hold in practical space, we are still not aware of that. The question-why is liquidity important? Still not been answered so far. Though its definition is enough to explain its importance, let this article simplify for you.
- Market Stability: High liquidity of bitcoin in the crypto markets ensures less uncertainty in the prices. When the traders on both sides i.e. on buying end and also on selling end is plenty in number, asset price will be affected minimally. Liquidity overpowers volatility, thereby benefiting the traders.
- Resistive To Manipulation: In the liquid markets, competitive prices of purchasing and selling the assets prevail. Manipulation by the whales or big investors is bit difficult due to robust marketplace and high trading activity.
- Quick Transaction Time: Better user experience is one of the advantages of highly liquid markets. High frequency of willing traders even at the times of high volatility, makes the smooth move on entry and exit points.
- Accuracy In Analysis: According to the analysts of crypto markets, higher liquidity in markets brings greater stability which facilitates precise and nearly accurate charting of the patterns of the market.
Thus, a highly liquid market is always preferable in crypto space.
Factors Affecting Liquidity In Markets
Only a single factor cannot be termed as a cryptocurrency liquidity provider. As the crypto markets is dependent on number of factors by number of traders, similarly liquidity is affected by number of factors:
- Volume Of Trade: Amount of coins that are being exchanged in a time frame of 24 hours, termed as the volume of trade.When traders who majorly trade and invest in crypto markets for the purpose of appreciation of prices instead of using their coins for medium of exchange, the liquidity of bitcoin got affected.
- Crypto Exchanges: Higher the number of exchanges, higher the number of marketplaces to trade resulting in highly liquid crypto space. An exchange is a marketplace where you can trade freely.
- Regulations:Being a decentralised currency, crypto is not managed by any central authority but regulated by the authorities. To protect the crypto traders, some countries compel the exchanges to follow the stringent rules and regulations. This results in lowering the liquidity. For instance, after the landmark verdict of Supreme Court of India which lifted up the blanket ban on the crypto sector, resulted in increasing the liquidity of crypto markets.
- Compliance To Assets: Many a times, new coins or assets are not being accepted by the masses or due to hacks in the exchanges, people lower down their trading. Therefore, mass acceptability of any token or coin is necessary for the liquidity of that particular asset.This one factor can be a crypto liquidity provider for a single asset.
How To Measure Liquidity?
Before trading on any exchange or exchanging any crypto coin, it is important to measure the liquidity of bitcoin to get the answers for where and what to trade? You must first focus on crypto exchange analysis, particularly on the trading volume of 24 hours with the help of sites like CoinMarketCap. You need to analyze the order book of the exchange focusing on stop-limit orders (price better than target price)and iceberg orders (large trade in small chunks). On the basis of various factors, some analysts are deriving the crypto liquidity index focussing on the indicators of order book while decreasing the effects of inflated trading volumes.
Solution To The Liquidity Problem
Liquidity can be a double edged sword. It can drown up your funds if not judiciously understood or can gain you millions if you can analyse the markets. You must remember a few points or must apply a few techniques to get through the cryptocurrency liquidity problem.
- Try to explore or trade on platforms which gives you the accessibility of multiple order books rather than choosing multiple platforms for number of books. For instance,SFOX,Tortoise etc
- Before trading on any exchange or investing in any coin, double check the credibility. Go through the reviews, recent announcements, twitter handle and their KYC compliance too.
- Diversify your crypto portfolio, which can protect you from the dry spells effects of the liquidity.
Thus, brush up your knowledge related to liquidity of bitcoin, otherwise you have to pay the hidden prices by trading on depthless exchanges or deceitful exchanges. Not considering it as academic subject, understand it and be a better crypto trader.
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