What is Liquidity and Why Does it Matter in Crypto Market
“Liquidity is the ability of you getting your money back from your investment as soon as you need it. Investor must ensure that the crypto asset he is investing in is liquid so that at the time of need he can get his money back without losing its value.”
What is Liquidity?
Liquidity can be termed as ease in which you can trade an asset for cash without affecting the market price of the asset. Or in more simpler terms liquidity is the ability of you getting your money back from your investment as soon as you need it. There are numerous asset classes in the stock market as well as the crypto market that have different levels of liquidity. The higher the liquidity of an asset, the better. Savings Account is one of the most liquid investments and hedge funds or real estate are the most illiquid ones.
Let’s understand it with an example. Suppose you have $1000 lying in your savings account or you have invested $1000 in stocks. At the time of need you can quickly withdraw money from the savings account or sell stocks (Though stocks are somewhat less liquid) and quickly have that money. On the other hand in the dire need of money an investment in real estate will be illiquid as finding a buyer quickly is not possible and even if somebody is found, the seller has to sell it at a discounted price thus incurring losses.
Why does it matter in the Crypto market?
There are multiple reasons that suggest the importance of liquidity in the crypto market or any financial market. These are discussed below:
Provides Stability
More liquidity means more market stability. If liquidity goes down, it can have negative effects on the stability of the market. In an example of Bitcoin, there are always buyers and sellers available to buy and sell making Bitcoin highly liquid in the cryptocurrency space. This is why the price of Bitcoin has been stable in the long run no matter how volatile it is in the short term.
Reduces Price Manipulation Risks
In an illiquid market the big players of the market can manipulate the market price of an asset to earn huge profits. The recent Squid Game Crypto scam was a perfect example of an illiquid crypto where the price was manipulated and raised so quickly that no liquidity on the exchange was left and the investors were not able to sell their investments and suddenly the creators took the currency off the blockchain with all the money. If liquidity is there, chances of manipulation is extremely low.
Lowers the Transaction Time
In a liquid market the transactions become fast and hence waiting time for a transaction to go through is quite less when compared to an illiquid time. In an example of real estate as the market is illiquid, finding buyers quickly is not possible and a change of hand might take several days and even months, but in Bitcoin, buyers are always available and hence, the transaction is done instantly.
Disclaimer: The article is meant for the educational purpose only and in no way it should be considered as financial advice. Own research on the topic is advisable.
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