In the cryptocurrency community, it is believed that with the launch of spot exchange-traded funds (ETFs) on Bitcoin in the United States, the crypto market will experience an influx of new liquidity. According to the analytical company Chainalysis, North America is the largest cryptocurrency market, with an annual turnover of approximately $1.2 trillion. This amount exceeds 24% of the global annual volume of transactions in cryptocurrency.
Leading market makers have already announced their readiness to provide liquidity for BlackRock ETFs. It is the lack of market liquidity that analysts call one of the reasons for the sharp jumps in the price of the first cryptocurrency.
The term “liquidity” is most often heard when cryptocurrency exchanges are compared on different parameters. Their other characteristics, such as security or the size of commissions, are also extremely important, but it is liquidity that has the most significant impact on the ability to get the best exchange rate for crypto assets on the platform.
Liquidity is essentially an assessment of the ability to buy or sell a particular asset at its current fair market value. For example, if you have Bitcoin and want to exchange it for dollars, there should be enough demand on the buy side for you to make the sale at the current rate.
If you want to sell $1 million worth of Bitcoin, and there are only $500,000 worth of buy orders close to the current market rate, you will sell some of your Bitcoins at a lower price. In addition, your sell order will lower the current bitcoin price because there were not enough buy orders at your requested sell price. The phenomenon of not being able to buy or sell a particular asset at the market price in large volumes is called slippage.
Cash is considered to be the most liquid asset in the world, as it can be used to buy almost anything without this slippage. Although Bitcoin is a form of digital money, its liquidity is nowhere near that of fiat currencies.
Liquidity and trading volume
Liquidity is often confused with trading volume, but these are two different concepts. There is usually a close relationship between liquidity and volume, but high volume does not necessarily mean high liquidity.
Trading volume is a measure of the value of trades executed over a certain period of time, which is usually measured on a daily basis. Liquidity has more to do with the buy and sell orders that are currently on the order books. In other words, trading volume is a measure of transactions that have already taken place, while liquidity is the number of buy and sell offers that can be executed on the exchange at a given moment.
There is not always a direct correlation between trading volume and liquidity, but still, an exchange with high trading volume attracts more traders. When it comes to cryptocurrency exchanges, there is a pronounced network effect, as everyone tends to go to the exchange with the most liquid market (due to the high level of user activity).
High trading volumes can attract new traders to a cryptocurrency exchange, leading to an increase in the number of buy and sell orders held on the balance sheet at any given time, and therefore an increase in liquidity. This has a compounding effect, as higher volumes and more users usually means that an exchange can offer more favorable commissions and fees, which only increases its value compared to other venues.
How liquid is Bitcoin?
In terms of the cryptocurrency market, there is no more liquid asset than bitcoin. Nevertheless, “whales” are still able to influence the bitcoin exchange rate through large buy and sell orders. This is due to a number of reasons, one of which is that there are dozens of different exchanges, and this creates price discrepancies across all markets. If all cryptocurrency transactions were conducted on a single centralized exchange, the market would undoubtedly be more liquid.
In traditional markets, liquidity is centered on a single exchange. For example, all Apple stock transactions are conducted through the NASDAQ exchange. In the case of cryptocurrencies, liquidity is spread across a large number of different venues. Although, as mentioned above, the network effect tends to result in most traders using only the largest platforms – Binance, Coinbase, OKX, Bybit, Bitfinex and a few others.
A liquid asset is defined as an asset that can be quickly converted into fiat money at a rate that is not much different from the price that can be obtained on the open market. Bitcoin can indeed be exchanged quickly, but there can be some slippage (price impact) when transferring really large amounts.
Exchange liquidity and cryptocurrency liquidity
The difference between exchange liquidity and cryptocurrency liquidity has to do with which one is being measured. When it comes to an exchange, it measures the amount of a particular cryptoasset that can be sold on that exchange without facing serious slippages. When measuring the liquidity of a particular cryptocurrency, it is necessary to consider all possible ways in which that cryptocurrency can be converted into fiat money or other assets.
When assessing the liquidity of a particular cryptocurrency, one should look at the order books (called exchange stacks) of all exchanges on which the asset may be traded. There are other variables, such as whether the cryptocurrency can be used to pay for goods or services. Bitcoin’s liquidity and trading volume has increased significantly since its introduction in 2009. Other highly liquid crypto assets include, for example, the Tether USD (USDT) stablecoin or other coins from the top ten in terms of capitalization.
The cryptocurrency exchanges with the most liquidity are also usually the exchanges with the highest trading volumes. Right now, the Binance exchange is seeing the most bitcoin activity on the BTC/USDT trading pair. Binance is also considered the main trading platform for most altcoins.
To trade a particular altcoin, you should pay attention to the trading volume and liquidity of that particular cryptoasset, not all the crypto-tokens traded on the exchange combined. Less capitalized altcoins are often traded on niche less popular exchanges that have more affordable coin listing terms.
In addition, there are also over-the-counter (OTC) brokers that help investors who want to trade large quantities of cryptocurrency while minimizing price impact.