In order to make good decisions when you invest in cryptocurrency, knowing the liquidity of your crypto assets is extremely important. Knowing how to measure liquidity in cryptocurrency can help you reduce losses when you buy and sell and make the most of your investments. While this might sound a technical and a little intimidating, it’s really not as complicated as it seems! Here, we’ll give you some tips on measuring your crypto asset’s liquidity so you can make the best buying and selling decisions in the exchange.
What is liquidity?
Liquidity essentially refers to how easily an asset can be exchanged for cash. In the world of cryptocurrency, a coin which is highly liquid can easily be converted to cash without disrupting prices. In general, coins which are more highly liquid are preferred because it means that the particular coin has a stable market.
Why is liquidity important?
Highly liquid coins benefit both buyers and sellers. When trading volumes are high, it means that sellers are selling at competitive prices and buyers are bidding higher prices. In this scenario, traders will benefit from fairer prices and no one will become particularly disadvantaged.
Besides fairer prices, traders will also benefit from faster transactions if the market is liquid. With many buyers and sellers in the market, you’ll be able to enter and exit a trade quickly — pretty important in cryptocurrency’s fast-paced markets.
How to measure liquidity
- Coin’s trading volume
We’ve mentioned that volume plays a big part in the liquidity of crypto assets so looking at trading volumes is key in helping you measure the liquidity of a coin. Greater volume essentially means trading activities are high and these trading patterns can give you an idea of the market trends of a given coin. When a coin with high trading volume drops in price, it signifies that the trend is influenced by the large volume of trade and not due to other factors like price manipulation.
On CoinMarketCap, you’ll be able to see the volume of trade for different coins in the last 24 hours. In this image, you’ll see that BTC is the most liquid coin, trading at more than $115 million.
- Trading pairs
Looking at trading pairs helps you make informed trading decisions. In any exchange, coins can be traded with other coins or traded against fiat currencies. Bitcoin, for instance, can be traded against USD, EUR, CAD (fiat currencies) and BCH, ETH, USDT (crypto coins). Knowing the trading volume between trading pairs is vital because it helps you understand the liquidity of a particular pair e.g BTC and ETH. To make the best trades, you should try to trade a coin pair with the highest level of liquidity. - Exchange’s trading volume
Besides looking at a coin’s trading volume, it’s also wise to consider the trading volume of different exchanges. An exchange’s trading volume is an indicator of the trading volume of all coins in the particular exchange and not just the trading volume of one coin.
The higher the trading volume of a particular exchange, the more participants are trading within the exchange and this means you stand a higher chance of enjoying better prices. You can visit Coin Market Cap to take a look at the trading volumes of different exchanges.
Currently, the largest cryptocurrency exchange is Binance, with a trading volume of more than $1 billion in the last 24 hours.
4. Bid Ask Spread
In an exchange, you’ll see a list which shows prices that buyers are willing to pay for coins (bid price) and prices that sellers are willing to sell their coins (ask price). The equilibrium where the Bid and Ask prices meet determines the market price of a particular coin. In the table, you can also work out the bid ask spread. The bid ask spread basically works out the difference between the highest bid price and the lowest ask price. The lower the bid-ask spread, the higher a coin’s liquidity and the cheaper it is to trade. Since bid-ask spreads differ between exchanges, it’s important for you to keep that in mind when you’re trading cryptocurrency coins.
While liquidity might sound a little intimidating and technical at first, it’s really not that difficult to figure out. Understanding the liquidity of your crypto investments is key if you want to make good buying and selling decisions. Prices of coins change rapidly and the cryptocurrency market tends to move at a fast pace. Thus, knowing which coins can be bought and sold cheaply and quickly will definitely put you at an advantage.
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