First let’s take a look at what liquidity is.
Liquidity is used in the financial markets to describe the ease with which an asset can be converted into cash. In the world of cryptocurrencies, liquidity implies the ability of the token or coin to be easily converted into cash or other coins (the base pair). If liquidity is on the higher side, this usually points towards a more stable market with little violent price fluctuations.
It is easy to trade cryptocurrencies in liquid markets because both your buying and selling orders will be filled swiftly when there are a large number of participants. Entering and exiting a trade under these circumstances is easy and can be done quickly at very low slippage.
Deep liquidity benefits both the exchange, the traders and the token project:
Exchange: exchanges make money on the trading fees charged on every trade, thus they want an actively traded market in order to rake in as many trading fees as possible
Traders: want to be able to constantly exit and enter positions at the lowest possible cost and risk
Token project: strong liquidity breeds confidence in the asset and also enables organic price appreciation
To ensure that there is liquidity most exchanges require the token projects seeking to get listed to take care of market making. This guarantees that there is liquidity for the traders. If a trader is looking to sell that company’s tokens and there is not a buyer, the company’s liquidity will be used to purchase the traders tokens. If a trader is looking to buy tokens, and there are no sellers then the company’s tokens will be used to sell to this trader. This is known as making the market and in the world of cryptocurrency this is done by crypto liquidity providers or crypto market makers such as Kairon Labs.
Crypto liquidity providers are experts that create complicated algorithms to regulate a coin’s liquidity. When done right, market making services executed by crypto liquidity providers attract organic users who know that they can instantly buy or sell a token on a given exchange.
It is important to consider the following aspects when discussing liquidity.
- If the market is more liquid, it is more stable. Lesser liquidity implies the lack of stability in its price movements. In order to execute a large trade order, the investor has to move through the order book which will increase the bid ask spread, either increasing or decreasing the overall price of the asset.
- The crypto space has been viewed as the Wild West because it has had a long history of price manipulation due to its poor regulatory framework. The lack of accountability makes manipulation easy. Liquid assets and exchanges are more resistant to such manipulations.
- In times of high volatility, the ability to enter and exit a position almost immediately creates more opportunity for profit.
- It also is believed that higher liquidity markets equate to increased accuracy in price analysis and predictions. This is because when the spread is tight (and consequently stable) it brings in more liquidity which creates reliable price and charting formation. When the ecosystem has poor liquidity there can be a huge impact on the tokens prices which can lead to insufficient data and consequently inaccurate charts which make analysis impossible or very inaccurate.
As such, it is extremely important that token projects work with reputable crypto liquidity providers to increase the likelihood of price stability and growth. Likewise, if you’re a trader, it’s crucial that both the asset you’re trading and the exchange you’re trading it on have liquidity.