- High liquidity is also desirable as it makes for stability without the tendency towards big swings as a result of large trades.
- Trading volumes are one of the main factors that impact on liquidity in the cryptocurrency market.
- Acceptance is a key factor when it comes to liquidity and cryptos will become more liquid as they become more increasingly used as a method of payment.
This article examines the role liquidity plays in a cryptocurrency exchange, why it’s important and highlights some of the key factors that affect liquidity in order to give a basic understanding of how it works.
What is Liquidity?
Liquidity is a common term used in the financial markets and can best be described as how easily an asset can be swapped for cash. When seen in the context of cryptocurrency liquidity it’s how easily coins can be exchanged into cash or other coins. Hence, the market can present either high or low liquidity levels. High liquidity occurs in situations where there is a stable market and few price fluctuations. Conversely, with low liquidity levels there is market volatility present which can cause spikes in the price of cryptocurrencies.
Why is it Important?
The ideal situation for the marketplace is the presence of high liquidity since it allows for the best prices for everyone as there are many buyers and sellers in the marketplace. High liquidity is also desirable as it makes for stability without the tendency towards big swings as a result of large trades. This is important as it may impact on cryptocurrency prices, causing increased volatility and risks generally for the market.
What Factors Affect Cryptocurrency Exchange Liquidity?
There are a number of factors which affect cryptocurrency exchange liquidity and these will be explored in the following.
Volume of Trades
It goes without saying that trading volumes are one of the main factors that impact on liquidity in the cryptocurrency market. You can check out the current state of affairs by visiting any one of the best known online cryptocurrency market cap rankings where a live display of daily trading volumes and other relevant information such as trading history and background are provided. High volumes indicate more participants in the market, hence more activity in the buying and selling of coins.
These days, there are more and more cryptocurrency exchanges in existence. This has resulted in additional opportunities for people to get involved in trading coins, leading to a more favourable situation in terms of crypto exchange liquidity. As we saw earlier, any increase in the frequency of, and volume of trading fuels better conditions and higher liquidity. Bullish and bearish trends will also impact on the prices of cryptocurrencies and their liquidity.
Acceptance is a key factor when it comes to liquidity and cryptos will become more liquid as they become more increasingly used as a method of payment. As we move towards greater acceptance, we can expect to see more and more merchants accepting this form of payment, which will impact on the overall number of transactions in the marketplace i.e. trading volume. This in turn will have a favourable impact on liquidity. Bitcoin and Ethereum have already been warmly welcomed by many traders which has made their liquidity higher than the majority of other coins in the cryptocurrency market.
Last but not least, regulations play an important role when it comes to liquidity as market size and the ways in which the markets move largely depend on government policies and the varying stances they take on cryptocurrencies. Some countries have gone as far as to ban cryptocurrencies and others have imposed strict rules, nevertheless, cryptos have gained acceptance and grown at such a great pace, that clear cut guidelines by the authorities in charge will inevitably result in more people wanting to get involved. This will of course impact on its liquidity.
In conclusion, keeping these important points in mind will provide a good understanding of how cryptocurrency exchange liquidity works and the reasons why the markets react in the way they do. Crypto exchange liquidity is important both for traders and providers alike. For the purpose of brokers looking to source a crypto exchange liquidity provider for their exchange, it is recommended that they should look at their own particular needs and make an informed choice depending on the overall package on offer by a liquidity provider, including market depth and fast execution, as well as favourable pricing.