Liquidity is an incredibly important concept that affects all crypto owners.
Despite that, it still cannot be considered common knowledge, and lots of beginners wonder how impactful liquidity really is and whether they should care about it too much.
Today, we collaborated with Edward Howarth of DashTickets to answer some of the most popular questions on the matter and guide you through the topic.
What is liquidity in cryptocurrencies?
Liquidity can be explained in simple terms: it is a measure of how easy it is to buy and sell a certain currency (like Bitcoin, for instance) without affecting its price. High liquidity means that it is a very easy thing to do, while low liquidity signifies the opposite.
However, as we provide this definition, we immediately understand that it only provides a surface-level understanding and raises many follow-up questions. Let’s try to answer some of the most popular ones.
Which type of liquidity is good, and which one is bad?
In general, high liquidity is preferable for all participants in the market. High liquidity ensures that all transactions are much easier to perform, there is much less price slippage, and exit strategies are much more consistent. It also means that the investment risks are lowered, which incentivizes more active trading.
On the other hand, low liquidity produces multiple risks for traders and creates a lot of unnecessary friction — increased volatility and price instability aren’t welcomed by most people, after all.
What affects liquidity in crypto?
The short answer is: lots of things. First and foremost, it’s all about trading volume and active participants, but factors like global financial stress, regulation, transaction fees, and multiple other variables can affect liquidity either way, and it can be almost impossible to analyze it in time to make correct financial decisions.
Predicting changes in liquidity is also something that we would leave to teams of analysts and wouldn’t recommend trying on your own due to how complicated and multi-faceted the issue really is.
What are the best strategies for low- and high-liquidity markets?
High-liquidity crypto markets enable you to trade in a traditionally normal way, providing security and reliability when handling large orders, ensuring quick buy/sell timeframes with reduced cost of trading. As a result, you can take advantage of small price movements and use algorithmic trading and market orders without having to worry too much about them. To put it simply, high liquidity is significantly less stressful and risky.
Low-liquidity markets require constant attention to execute trades during perfect hours. Market orders become highly unreliable and dangerous, which is why we recommend never using them in these scenarios. Finally, operating with sharp price swings and no reliable exit strategy is incredibly difficult, so if you aren’t 100% sure what you’re doing, it is better to avoid these markets.
