Liquidity in Crypto Markets: Why It Matters, How It Works, and What Happens When It Disappears
Liquidity is one of the most significant aspects of the crypto market that people refer to when discussing it. Liquidity refers to the ease with which a coin or a token can be purchased or sold without much adjustment in its price. When a market is liquid, it is possible to trade fast and at a fair price. In case it is not liquid then you have to wait a long time to sell or you may even sell at a bad price. An insight into liquidity, in my view, is one of the secrets to the functionality of the crypto markets.
Liquidity is important as it indicates the wellness of a market. As an example, the most liquid cryptocurrencies are Bitcoin and Ethereum. The current trading volumes of Bitcoin according to CoinMarketCap stand at more than 15 billion dollars per day and this implies that Bitcoin is being traded by many people on a daily basis. This ensures that any individual can get into or out of positions easily. Smaller coins, which are also referred to as altcoins or shitcoins, are usually very liquid. When you attempt to sell them you might find that the price drops very fast due to lack of sufficient buyers. This demonstrates the fact that liquidity is so valuable to investors and traders.
In order to learn about the working of liquidity, we have to consider market makers and order books. In other exchanges such as Binance or Coinbase, there are bids and asks posted by buyers and sellers respectively. The spread between the two prices is referred to as the spread. A very small spread implies the market is liquid since buyers and sellers are in close agreement with regard to value. Market makers either professional traders or even automated bots come to the rescue in terms of continuously providing buy and sell orders to maintain the market. Indeed, the market makers are often paid by crypto exchanges to have liquidity at all times. It would be difficult to trade without these actors.
Decentralized exchanges (DEXs) are another form of creating liquidity. Liquidity pools are offered by people in services such as Uniswap or PancakeSwap by locking their tokens in smart contracts. Directly out of these pools, other traders are able to swap tokens. It has been easier to get new coins liquid under this system and at the same time it has its risks. In case a large number of individuals withdraw their money off a pool, the liquidity is gone at an extremely high rate and this may render it impossible to trade such a token.
But what will happen when there will be no liquidity? Here things may get serious. In cases where there is a shortage in liquidity, prices are highly unstable. As an example, on the day of the crypto crash in March of 2020, Bitcoin devalued by almost 50 percent. Liquidity issues were later cited as one of the primary causes by analysts who said that too many people were attempting to sell, but not enough buyers existed at consistent costs. The other case is smaller tokens whereby a large sell order can lead to the crash of the price due to the thinness of the market. This results in panics and in most cases, a so-called liquidity crisis.
I have also learned that liquidity in crypto is an issue that regulators and financial researchers monitor attentively. One time, the Bank for International Settlement stated that it is possible to see crypto markets appear deep and active on the surface, and in case of stress, the liquidity can disappear more rapidly than in the traditional market. It renders crypto riskier, particularly to individuals who invest in coins with small market cap. Regarding my own research, I found that in the conventional type of stock market, the liquidity is often more consistent due to the presence of institutions, central banks, and stringent rules. However, in crypto, all is a matter of confidence of traders and investors, and at evening they may alter.
The liquidity also influences the prices and the project value. When a coin is of low liquidity, large investors tend to keep off their investment since they cannot invest huge sums without causing the price to go either high or low. This is the reason why project teams in crypto will always attempt to promote the extent of liquidity that exists over their token. They do this even on DEX platforms by locking liquidity away months or years in a bid to build trust with investors. It demonstrates that they will not be ready to withdraw the money at a glance.
Personally, I have also learned one life lesson when it comes to the playing with liquidity in the crypto markets: value is not necessarily what something is worth, but also how easy it can be traded. Just as in trading, liquid opportunities in life are the ones that can be captured promptly with a relatively low cost. However when it is illiquid, you have a chance of getting stuck even though you have something of value. This lesson has ensured that I am cautious when it comes to trading as well as my handling of time, money, and even relationships.
To sum up, the crypto markets are liquidity. This is important as it renders the process of trading easy, consistent, and appealing. It operates with order books, market makers and liquidity pools that make the system active. However, once it is gone, mayhem may ensue resulting in price drops and market crises. History and research have revealed that liquidity in crypto is not necessarily consistent, and that is the reason why it is something traders like me must be keen on. Liquidity is not an option but a necessity to anyone looking to become successful in crypto.