Have you ever visited sites about cryptocurrencies? Then you have undoubtedly come across the term liquidity which seems to resemble a holy grail for every crypto trader. What is it and why is it important to consider, when creating an investment plan? That is the main topic discussed by the following article.
What Is Liquidity?
Dictionaries explain the term liquidity as a state when a particular asset can be bought or sold without affecting its price stability. Even high volume orders do not change the price to a greater extent. On the first glance, this seems not as an issue of cryptocurrencies, which are well known for the opposite — volatility. But for an exchange, it is important to get as close to liquid assets as possible. Mainly by facilitating a high volume trading.
Liquid assets such as commodities, currencies, stock, and bonds have an opened market. It is possible to make thousands of transactions in one moment without any significant price movements. The illiquid assets such as art, antiques, or real estate do not possess similar platforms and find their place on private sales. It is also almost impossible to precisely evaluate the price of the asset while the opened markets respond immediately with a statistically precise data.
What Affects Liquidity?
Liquidity is affected by four important factors:
- Trading Volume
- Acceptance
- Cryptocurrency Exchange
- Regulations
The trading volume is the most significant factor affecting the cryptocurrencies price. It refers to the number of coins traded during the last 24 hours. It reflects the activity of the investors — higher it is, the more actively they are buying and selling the currency. It is closely linked to one of the reasons of high volatility of cryptocurrencies — they are used for investments and speculations but do not serve as a medium of exchange.
The issue of acceptance is another problem. Merchants and businesses must recognise cryptocurrencies as an equal mode of payment to help them gain stable value. The situation has improved drastically in the latest years with more than 400,000 merchants including Amazon, Apple or Microsoft accepting payments in Bitcoins.
Cryptocurrency exchanges and marketplaces support the liquidity since they help more investors to get their hands on the coins. They create an environment in which buyers and sellers can interact freely and invest in any asset they want to. Currently, more than 200 cryptocurrency exchanges, as well as several decentralised markets and other platforms, are functional and many more should appear in the nearest future.
Laws and regulations can have both a negative and positive effect on the liquidity. It grows if the rules create only a legal frame but keep a market free. However, some countries consider imposing a ban on cryptocurrencies or their exchanges which means that the buyers and sellers would lack any official platforms. They would need to stick to private transactions or peer-to-peer programs. The prices would go higher since a low number of sellers would be able to saturate the increasing demand.
How to Increase It?
An increased cryptocurrencies liquidity is achievable. As soon as they start to behave like a traditional asset integrated into the conventional economy and widely accepted as a payment mode, they would gain much more stable prices. However, it may lead to the negation of the concept standing behind their creation.
More people should get access to buy and sell cryptos and increase the trading volume. The greater money spinning in the crypto wheel means higher stability because of the greater reserves. In a small market, every large order changes the value by tens percents since the market is not able to absorb it. That would, however, mean to adopt a stricter law and to limit the decentralisation of the currencies to some extent.
That is where we are getting back to the fundamental question people interested in cryptomarket are looking an answer for: Can cryptocurrencies become a stable market asset without losing a part of its identity? What do you think?
Is the current cryptocurrency market at its final and definitive stage or should we expect turbulent evolution of crypto money in a near future?
