What Is Liquidity?

In its simplest form, liquidity indicates how easy it is to quickly convert a cryptocurrency into cash — and whether this can be achieved without the asset’s value suffering.

Bitcoin, the world’s first and most actively-traded digital asset, is often recognized as the most liquid virtual currency. 

Liquidity can also be used when weighing exchanges that enable trades between fiat and crypto to be completed instantly without price slippage. The levels of liquidity will often depend on how many users that particular platform has. In a perfectly competitive market, liquidity will erode the ability to charge a discounted price or a premium. This is because active trading of a cryptocurrency or any asset class helps avoid price distortions. 

A cryptocurrency that is liquid typically trades around its market price. The most liquid market in the world is the forex market. On average, it recorded $6.6 trillion in daily transactions a day as of April 2019, according to the Bank for International Settlements. On the other hand, the real estate market is typically considered to be illiquid. This is because properties are often not easily sold, and can involve a long chain, a lot of paperwork as well as be subject to other variables. 

Liquid markets are typically preferred by traders. An illiquid market makes it very difficult for participants to enter and exit positions. 

Trading volumes for Bitcoin are now comfortably in the tens of billions on a daily basis and have grown substantially since 2014. This is not to say that the bellwether currency has never experienced bouts of illiquidity. Once BTC prices crashed in 2018, volumes plummeted to around $5 billion per day. 

The liquidity of cryptocurrencies is likely to increase further if adoption rises and virtual assets become more widely accepted as mediums of exchange.