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Liquidity 101: The State of Crypto

Liquidity is a key metric investors need to look at when investigating a new asset they might want to trade. But what is liquidity, why is it important, how do we measure it, and what drives liquidity?

These are some of the questions we’ll be looking at here. 

Let’s start with a simple definition: Liquidity basically refers to the ease with which an asset can be exchanged for cash, without overly affecting the price of that asset. The two main components here are speed and price. For an asset to be liquid, traders need to be able to exchange their asset for cash quickly without too much price slippage. 

Liquidity reaches across a number of layers:

  • Asset liquidity
    • How easy is it to find and access a marketplace where you can trade your asset, are there enough buyers and sellers for a specific asset? 
  • Exchange liquidity 
    • How many pairs are listed on the exchange, and are there enough makers and takers moving the market? 
  • Market liquidity 
    • What is the overall state of asset and exchange liquidity across a certain market of asset class? 

Why is liquidity important? 

Stability: Liquidity is closely related to volatility, and by extension, stability. When you’re buying or selling Bitcoin, there are usually plenty of traders on the other side willing to fill your order, without too much price impact. 

But when it comes to less traded altcoins, such stability cannot be assumed. For a large market order to be filled, you might have to move through the order book filling orders across levels and by the time your trade has been executed, the bid ask spread will have increased and the price of the asset will have changed. 

Market integrity: Market integrity, one of our core principles, is often described in terms of anti-money laundering policies, Know Your Client (KYC) procedures, transparency around price, and information flows. Liquidity, however, is a key element to consider. Low liquidity makes it easier to set up buy and sell walls, drive the price up or down, build bull and bear traps, and send false signals to the market.

Transaction speed: Higher liquidity implies that it is easy to get your orders filled. On the one hand, this is a technical matter; for example, with AAX we’ve deployed one of the fastest matching engines in the world, developed by London Stock Exchange Group’s LSEG Technology, but liquidity is equally important – if no one is trading, the matching engine won’t be of much help. 

Accuracy in technical analysis: Technical analysis is a widely used technique in the crypto markets. Tighter spreads and greater stability and more trades means more information is feeding into price charts, making it easier to identify patterns and trends. 

How to determine whether an asset or market is liquid? 

There are a number of things you can look at in order to determine whether or not an asset or market is sufficiently liquid. 

  • Trade volume
    • Daily trade volume for a certain asset and per exchange is obviously an important indicator you might want to look at. For this, you can go cryptocompare.com or coinmarketcap.com to find out what trade volume looks like for different markets. 
  • Outstanding orders
    • To gauge an asset’s liquidity on a certain exchange, you might also want to have a look at the local order book to see how close buy and sell orders are to the current price, how thick the orders are, at least for the top 5 price levels, and also how deep the book goes.
  • Number of traders 
    • In addition to the order book, you might also want to get a sense of the number of users on a given platform. If there are only two traders filling up an entire order book, and you come in trade against them, you might find yourself at a disadvantage. Low trading fees generally attract more traders, and the higher the number of traders, the more liquidity. 
  • Bid-ask spread 
    • The bid-ask spread is the amount by which the ask price exceeds the bid price for an asset in the market. The bid-ask spread is essentially the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.

Are crypto markets liquid? 

As a form of digital cash, Bitcoin and other crypto assets meant to revolutionize payments, crypto cannot yet be said to be liquid in the same way as the US dollar. 

But overall, it is generally easy to trade Bitcoin, Ethereum and other major crypto assets. But for smaller altcoins that may not always be the case. 

What’s important to know, however, is that a lack of liquidity is not always a bad thing. As you know, illiquid assets such as real estate, are very popular and generally seen as a top investment asset. Lack of liquidity (and volatility) can mean that potential returns can be particularly attractive. Furthermore, what you’ll find in crypto is that the price of assets – including Bitcoin – may differ quite a bit across exchanges. This presents very attractive arbitrage opportunities for traders. 

What drives liquidity? 

Lastly, since liquidity is important to the overall health of the market, and for crypto to fulfil its role as medium of exchange and store of value. What needs to be done?

  • Build more fiat-to-crypto on and off ramps 
    • It needs to become easier and easier to convert your money to crypto and back; this will make it easier for investors to engage various exchanges, which ultimately improves market efficiency and price consistency across markets.
      • Our solutions: We make buying and selling crypto for cash easy with our over-the-counter trading desk, as well as through our partnerships with various payment providers.
  • Market makers 
    • Every crypto exchange works with market makers – parties that will agree to trade on your platform, either in exchange for a reduction in fees, or even for payment. Their task is to make the order book, and sometimes fill orders as well.
      • AAX is constantly engaging market makers to drive more liquidity.
  • More capital
    • The more investors enter the market and inject capital into the markets, the more likely it is for an asset/ market to be liquid.
      • AAX is focused on offering a suitable environment for institutional investors, knowing that these regulated investment communities are key to increasing crypto’s market capitalization. 

Trade with AAX 

AAX is the world’s first digital asset exchange to be powered by LSEG Technology. Offering OTC, spot, and futures, it provides a highly secure, deeply liquid and ultra-low latency trading environment; and a meeting point between crypto and global finance. 

Open an account with AAX, or download the app, and experience the next generation crypto exchange.

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