Liquidity

The ability to effectively buy or sell an asset whenever the investor desires is one of the most important aspects of any investment. Profits are worthless if they cannot be realized.

An asset with a high trading volume is considered to be highly liquid. With these types of assets, you can be sure to receive a reasonable offer,as there is always a large number of potential buyers and sellers.

All tradable assets, including cryptocurrencies, require liquidity so they can be traded properly. Liquidity can be defined as the ability of an asset to be quickly exchanged for fiat currency.

If liquidity levels are low, the market is volatile, causing cryptocurrency prices to fluctuate. In contrast, a market with high liquidity is stable, with little price fluctuation.

When trading cryptocurrencies, it is important to understand the concept of liquidity. In this context, it refers to the ease with which tokens or coins can be exchanged for fiat or other currencies.

Why is liquidity important?

If there are a lot of buyers and sellers in the market, it will have high liquidity, resulting in better prices for all traders. Markets that are constantly evolving and are highly active result in a fair market price that is acceptable to all parties.

Low liquidity – It is important to note that low liquidity in a trading pair can have a significant impact on the price of one or both assets. In a trading pair with low liquidity, it is less likely that the value of one or both assets is accurate. In the crypto world, this phenomenon is common, since crypto assets can easily be created and listed on decentralized exchanges (DEX) or centralized exchanges (CEX).

For instance, token A with a total stock of 1 billion tokens may be listed on the DEX as a A/$USDT pair. The market price of token A is now 1 USD, making the market cap of token A 1 billion USD, assuming an investor pays 1 USDT for one token A. The token's price will remain at 1 USD if no one else trades it; i.e., the liquidity remains at virtually zero. It is important to note, though that even the slightest purchase or sale of token A will have a significant impact on its value.

How to determine liquidity:

In contrast to other trade analysis indicators, liquidity does not have a fixed value. Due to that fact, it is difficult to determine the exact liquidity of an exchange or market. Nevertheless, there are certain signs that can be used to determine the liquidity of cryptocurrencies.

• In the order book, the bid-ask spread is the difference between the highest bid (selling price) and the lowest ask (buying price). A cryptocurrency with a smaller bid-ask spread is considered to be more liquid.
• Trading volume plays a significant role in determining the liquidity of the cryptocurrency market. It refers to the total amount of digital assets that have been exchanged on CEXs over a specific period of time. Market direction and investor behavior are influenced by this, and a higher value of trades indicates more trading activity (buying and selling), which indicates more liquidity and a more efficient market. Low trading volume, however, indicates a lack of trading activity and low liquidity.
• Market size – cryptocurrency markets, including bitcoin, are currently relatively small. An asset’s market capitalization is calculated by multiplying the total amount of the asset by its price. At the current ATH (All Time High) price of around 69,000 USD per BTC, with the total number of BTC mined at roughly 19 million, the total market capitalization of bitcoin is approximately 1.3 trillion USD. (19,000,000 BTC x 69,000 USD = 1,311,000,000,000 USD).

This may seem like a large number to a retail investor, but unfortunately, this is not the case. In fact, in comparison with other assets, cryptocurrencies are still very much in the background, hence why professional investors have generally avoided the market.

Here are a few examples of liquidity:

Global Equities: 106 billion USD

Global Fixed Income: 124 billion USD

Gold: 12 billion USD

PROs

• Reduces price manipulation
• Improves market stability
• Improves market analysis

CONs

• If it is low, the asset will be highly volatile
• Inability to sell its assets when liquidity runs out

How to work out the liquidity of a token / coin

It is important to verify that the token or coin has sufficient liquidity before making any investment. Do not rely on YouTube influencers or project developers; instead, check the contract for the pair to which the DEX purchase relates in order to verify the token's liquidity for yourself.

Here are the instructions:
- Go to Dexscreener and search for the token you wish to purchase, such as token Cake, and in which pair you wish to purchase it. For our example, we will use a pair with a token WBNB.
- As a result of the search, you will see a chart. In the bottom right corner, you can find information regarding the contract of the CAKE / WBNB pair, and the split of the pool
- Copy the 'Pair' contract and go to bscscan.
- Enter the contract information into the search box to view the contract information.
- To determine how many tokens are in the pool, locate the 'Token' row and click the box.

The CAKE/WBNB pool on PancakeSwap has approximately 112 million USD in CAKE and 112 million USD in WBNB. Due to this, CAKE has high liquidity, which means that purchases of thousands to tens of thousands of dollars are unlikely to significantly affect its price.

If liquidity of an asset is in the tens of thousands of USD, this asset will be highly volatile when sold or purchased.

Conclusion

An important factor in choosing investments is liquidity. As a general rule, it is better to trade in markets with high liquidity, as you will be able to enter and exit positions fairly easily.