Liquidity is the ability of an asset to be quickly sold or bought at a price close to the current market one without significant loss in value. The more active buyers and sellers there are in the market, the higher the liquidity: trades are executed almost instantly, and the difference between the best buy and sell price (the spread) remains minimal.
In the cryptocurrency market the level of liquidity differs noticeably from asset to asset. Large coins with high market capitalization and a wide presence on exchanges usually trade easily and with a narrow spread. Little-known tokens with a small number of participants may turn out to be low-liquidity: an attempt to sell a large volume can noticeably push the price down, and buying can push it up.
Why liquidity matters
- It allows entering and exiting a position without significant slippage.
- It narrows the spread, reducing the hidden costs of trades.
- It makes market quotes more stable and predictable.
- It reduces the risk of manipulation to which thin markets are prone.
When assessing liquidity, traders look at trading volume, the depth of the order book and the number of venues where the asset is traded. High liquidity is a sign of a mature and in-demand market, whereas a lack of it increases the risks and unpredictability of operations.
