As in the Wild West, a crypto exchange that is quick and fast to the draw can hope to stay alive a little longer
Liquidity can spell the difference between the success and failure of a cryptocurrency exchange. Liquidity means that a trader can easily buy or sell assets on the platform without the price being affected. A trader will choose an exchange platform where transactions can be completed quickly in a cost-effective manner. Without it, chances are, the platform may be struggling with low liquidity which can effectively lose traders. Liquidity has two aspects: ease and price. Ease refers to the speed and effort, while price refers to the slippage or the difference between the executed price and the expected price. Both are critical components a crypto exchange must consider if it wishes to be successful in the long term.
Levels of Liquidity
Going into the specifics, there are three levels of liquidity in the cryptocurrency market. They are asset liquidity, exchange liquidity, and market liquidity. Asset liquidity is the function of how buyers and sellers find a specific asset easily accessed in the exchange. Exchange function, meanwhile, concerns the function of makers and takers on the exchange platform, including the listed asset pairs. The stable and transparent performances of asset liquidity and exchange liquidity put together constitute the overall health function of the cryptocurrency market, termed as market liquidity. That is why beyond the knowledge of fundamentals and technical analysis, buy and sell strategies must include liquidity of the asset and the venue where transactions must be executed.
Importance of Liquidity
Liquidity is oft-spoken about in the financial markets, owing much to the fluidity of asset-to-fund transfers without affecting prices. The importance of liquidity rests in the following.
Liquidity and stability go together. A high liquidity market signals robust stability. For example, Bitcoin’s high liquidity makes the market price stable even when there are large trades of buying and selling happening on the sides. However, the price of a lesser-known cryptocurrency of lower liquidity will surely be affected by a large trade. This is because the large trade of a single transaction can take up a large portion of the order book, incurring a higher average price, or lowering it if traders are selling. Standing orders left will not credibly represent the price of the asset averaged accordingly across different exchanges. Platforms with high liquidity, on the other hand, can take a rapid burst of transactions without eating up its order book, leaving investors and traders satisfied.
Resistance to Manipulation
A crypto market with only a pinch of regulation and full of anonymous traders the world over is apt for a digital Wild West. Price manipulations coupled with non-accountability abound. Low liquidity assets are in for manipulation. Wherefore, liquid environments for assets and exchanges can withstand and resist any manipulation of any kind.
High liquidity can attract traders and, therefore, can fill up orders faster. Frequent traders can take advantage of high liquidity by strategically entering and exiting during volatile times, profiting highly in the process.
Accuracy in technical analysis is a strategy employed by almost everyone in the crypto market. High liquidity environments increase accuracy because with great stability and tight spreads, charting formation is more precise and developed.
Measuring liquidity is a determining factor to identify where to trade and what to trade. While it is helpful to look at the 24-hour trade volume of an exchange, the data can limit your options. But then that is where you need to start, then add the order book depth and the bid-ask spread. A metric released by CoinMarketCap called “Exchange Liquidity” is proving to be a valuable instrument in reducing the influence of inflated volume metrics. It calculates it by a range of key variables from the order book, such as the distance of the order from the mid-price, the size of the order, and the relative liquidity of the asset in question.
We know that given the chance, we can benefit not only with high liquidity but also with low liquidity. As low liquidity can signal unstable prices for an asset, probable manipulations, and scary long waiting times due to lack of players, it can benefit the wise trader. Large orders can depress the price of a low liquidity asset, but it can open up an opportunity to buy the asset at its discounted price.
As you go along with the frequency of your trading, knowledge of liquidity can help you build strategies concerning the acquisition of assets and the selection of exchanges with a favorable liquidity atmosphere.
Committed exchanges, for their part, can increase their credibility by going beyond the limitations previously mentioned. They can choose among three promising options for continuing liquidity strategy: third-party market makers, cross-exchange market making, and liquidity mining. These liquidity solutions depend on capital and operational capacity. There is no one-size-fits-all strategy, but exchanges can provide their traders with the liquidity they are craving for.
As in the Wild West, a crypto exchange that is quick and fast to the draw can hope to stay alive a little longer.
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