What Liquidity Means For Cryptocurrencies | by Bitxmi Exchange | The Capital | Mar, 2022

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When comparing different cryptocurrency exchanges, one of the terms that get thrown about the most is liquidity. While other cryptocurrency exchange characteristics such as security and fees are critical, liquidity can have a significant impact on an individual’s ability to obtain a fair exchange rate for their crypto assets.

What Exactly Is Liquidity?

Liquidity is a measure of an asset’s capacity to be purchased or sold at its present fair market value. For instance, if you own Bitcoin and wish to exchange it for US dollars, there must be sufficient demand on the opposite side of the order for you to complete the transaction at the current exchange rate.

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If you wish to sell $1 million worth of Bitcoin and there are only $500,000 worth of buy orders at the current market rate, you will wind up selling some of your Bitcoin for a lower price than the currently accepted exchange rate. Additionally, your sell order will result in a decrease in the current Bitcoin price, as there were insufficient buy orders at your proposed sell price.

See also: Five cryptocurrencies set to explode in 2022.

What is slippage?

Slippage is the inability to buy or sell a particular asset at the market price in substantial numbers.

Cash is widely regarded as the most liquid asset in the world due to its ability to be used to purchase virtually anything without incurring any fees. While Bitcoin is meant to function as a type of digital cash, it lacks the liquidity found in fiat currencies such as the US dollar.

Volume vs. Liquidity

While liquidity and volume are frequently used interchangeably, they are not the same thing. While liquidity and volume are frequently inextricably linked, great volume does not always imply high liquidity.

Trading volume is essentially a measure of the value of trades done over a specified period, which is often daily. On the other hand, liquidity is primarily concerned with the buy and sell orders currently on the order books.

In other words, volume is a measure of completed trades, whereas liquidity refers to the buy and sell offers currently accepted on the exchange.

Why Does Increasing Trading Volume Result in Increased Liquidity?

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Although there is no direct correlation between trading volume and liquidity, an exchange with a high volume of trading will tend to attract more traders. When it comes to crypto exchanges, there are extreme network effects at work, since everyone wants to be on the exchange with the most liquid markets (due to the high level of activity).

Increased trading volume may draw new traders to a cryptocurrency exchange, resulting in a higher volume of buy and sell orders on the books at all times — implying a higher level of liquidity.

This has a compounding impact, as bigger volumes and more users often equate to lower fees and rates, hence enhancing the exchange’s value proposition relative to competing exchanges.

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Is Bitcoin Considered a Liquid Asset?

There is no more liquid asset in the cryptocurrency industry than Bitcoin. Despite this, Bitcoin whales continue to be able to influence the price of the cryptocurrency through their huge buy and sell orders.

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This could be for a variety of reasons, one of which is the existence of hundreds of separate exchanges, which results in price disparity among marketplaces. If all bitcoin transactions were instead conducted through a single centralized exchange, the market would undoubtedly be more liquid.

A liquid asset is one that can be converted into cash rapidly and at a price that is not significantly different from the open market price. Although the nature of Bitcoin enables rapid conversion to cash, people moving exceptionally large sums of Bitcoin may see some slippage.

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It’s worth noting that Bitcoin’s liquidity and trade volumes have grown substantially since the technology’s infancy. Additionally, highly liquid assets such as USDT, which is essentially a peg to cash, and Ripple, which is heavily used by banks and financial organizations, are available on most exchanges.

Liquidity on Exchanges vs. Liquidity on Cryptocurrencies

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The distinction between exchange liquidity and cryptocurrency liquidity is in the unit of measurement. In terms of an exchange, you’re determining the maximum amount of a certain crypto asset that you may sell without experiencing significant slippage. When determining a cryptocurrency’s liquidity, it’s important to consider all of the many ways that cryptocurrency can be converted to cash or other assets.

To determine the liquidity of a cryptocurrency, you’ll want to examine the order books of all exchanges where that asset may be traded, as well as other criteria, such as the crypto asset’s acceptance by payment processors.

Which Cryptocurrency Exchanges Have the Highest Level of Liquidity?

The most liquid bitcoin exchanges also tend to have the biggest trading volumes. Binance is currently the trading platform with the greatest Bitcoin activity via the BTC-USDT trading pair. Additionally, Binance is the primary trading platform for a huge number of altcoins.

If you’re wanting to trade a single altcoin, you’ll want to ensure that you’re comparing trading volumes and liquidity for that particular crypto asset, not for all of the crypto tokens traded on the exchange. Oftentimes, smaller altcoins are traded on specialized exchanges.

It’s worth noting that there are also over-the-counter brokers who assist investors looking to trade a huge volume of bitcoin with the least amount of slippage possible.

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Liquidity in the Stock Market vs. Liquidity on Cryptocurrency Exchanges

There is little difference between how a stock market and a cryptocurrency exchange operate in terms of liquidity. In both instances, the same fundamental concepts apply.

There is, however, a critical distinction between how liquidity works for equities and cryptocurrencies more broadly. A stock’s liquidity is consolidated on a single exchange. For instance, all Apple stock transactions take place on the Nasdaq. Liquidity in cryptocurrencies such as Bitcoin is distributed among a huge number of different exchanges. Although, as previously stated, network effects tend to concentrate the majority of traders on a few exchanges.

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