Liquidity in Cryptocurrency Overview, Importance

Volume refers to the number of coins traded in a single market during a given period of time. Volume  can indicate the direction and movements of the current market trend. Greater trading volume equates to more trading activity (selling and buying) and is therefore a liquid market. Additionally, a higher volume backing a market trend – either a decrease or increase in cryptocurrency prices – signifies higher market activity backing the overall trend. For example, a drop with considerable volume behind it might mean a coin is in for an extended bear run. If price movements are not backed by volume, this would however indicate that only a small number of people are backing the current price trend and therefore, it may be short-lived.

(1), which was used by several studies (Kamara et al. 2008; Korajczyk and Sadka 2008; Marshall et al. 2012). Such studies highlighted its superiority over other low-frequency liquidity proxies, which often do a poor job in capturing liquidity in financial markets. Brauneis and Mestel (2018) also used this measure for the computing liquidity for the cryptocurrency market. This section provides a brief overview of the literature related to the topic.

How to use volume indicators?

Finally, the third part is the methodology section, that is, the frequency connectedness framework of Brunik and Krehlik (2016). This framework allows us to capture the time–frequency dynamics of the liquidity connectedness among cryptocurrency markets. Technical analysis refers to the study of past prices and the use of technical indicators and charting patterns to predict cryptocurrency prices. Though many disagrees with the accuracy of technical analysis, it is still a widely-used methodology in understanding the general market and trading. Price and charting formation in a liquid market is more developed and precise, thereby enhancing its accuracy. It’s much more convenient and easy to buy or sell the cryptocurrency of your choice in a liquid market since your buy or sell orders would be filled much faster due to the greater amount of market participants.

  • Accounting liquidity measures how liquid a custodial institution is, and how easily it can use its liquid assets to meet financial obligations, ensuring the efficiency of their resource flow system.
  • On the other hand, real estate, exotic cars, or rare items may be considered relatively illiquid, since buying or selling them isn’t necessarily an easy feat.
  • On a centralized exchange, liquidity is achieved by employing market makers and high-frequency traders.
  • Insufficient liquidity is an error that some decentralized exchange users, especially the PancakeSwap decentralized exchange, encounter during some transactions, which is an obstacle for their transactions.

Consequently, through these trading dynamics, the investor’s time horizons could well be reflected in crypto liquidity and its connectedness. An exchange is a marketplace where assets are traded freely between buyers and sellers. A higher number of cryptocurrency exchanges signifies greater market (and trading) activity since there are more avenues that individuals can get their hands on cryptocurrencies. The increase in frequency and volume of trading helps to enhance market liquidity. There are currently over 200 cryptocurrency exchanges, 21 decentralized exchanges and a handful of peer-to-peer (P2P) platforms in existence today. There are many other exchanges that are currently work-in-progress and due to launch in the near future.

Liquidity Explained

However, the BTC/LTC pair always appears in the same cluster, showing the complementary nature of assets under different scenarios. From another perspective, Dash and ETH appear in different liquidity clusters, indicating the substitution opportunities in different frequency domains. Nevertheless, the spread of liquidity clustering in the full-sample and frequency domains remains unaffected. Notably, in 2017, the prices of sample cryptocurrencies exponentially increased,Footnote 10 and many new currencies entered the digital currency market.

How Is Crypto Liquidity Measured

This pool can then be used by users to exchange tokens or to make transactions, however, can’t be withdrawn by the original depositor. This process ensures that liquidity is maintained in the pool and that no tokens are removed from circulation. Liquidity in crypto markets is a measure of how easily one can buy or sell an asset without significantly impacting the price. A financial crisis can have a significant impact on liquidity as market players rush to the exit to cover their financial obligations or short-term liabilities.

How Is Liquidity Measured?

This is why traders pay attention to things like the bid-offer / bid-ask spread and market depth. In a liquid market, investors can easily buy and sell assets at narrow spreads, which reduces the cost of trading. This is especially important for traders who have to buy or sell large amounts of assets, as they can incur high costs if the spreads are wide.

Moreover, in terms of net spillovers, BTC, Dash, and XMR are net receivers of liquidity spillovers, whereas LTC, XRP, and ETH are net transmitters. Liquidity is a crucial facet of today’s financial markets that encompasses ease, speed, and affordability that an investor can trade. Liquidity is of great relevance to investors and policymakers, as a systematic liquidity factor exists in many financial markets (Chordia et al. 2001; Marshall et al. 2013).

BTCC trading guides

Institutional investors’ liquidity buildups in the cryptocurrency market also potentially strengthen the demand-side channel of liquidity connectedness through correlated trading. Finally, volatility may also induce liquidity connectedness (Chuliá et al. 2020), which aligns with the theoretical framework proposed by Brunnermeier and Pedersen (2009). According to this framework, higher market volatility contributes to a rise in liquidity connectedness, which results from a decline in liquidity provision available for financial intermediaries. Liquidity is an important concept to understand when trading in financial markets. It refers to the ease with which assets can be bought and sold and is a key indicator of market health.

How Is Crypto Liquidity Measured

It’s the difference between your intended price and where your trade is executed. High slippage means that your trade is executed at a very different price than what you intended. This usually happens because there aren’t enough orders in the order book close to where you intended to execute them.

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As we previously mentioned, the liquidity in the stock market dried up rather quickly in the stock market crash of 2008, and again in the pandemic-induced crash of 2020. Situations like these can cause serious problems, as investors are suddenly unable to exit a position. Stargate is a cross-chain liquidity transfer protocol that enables users and dApps to move native tokens across chains and access unified liquidity pools. The bid-ask spread is the difference between the lowest ask (sell order) and the highest bid (buy order). A close order book spread also means low slippage in case the orders at the prevailing price get exhausted. In this blog we discuss the academic research surrounding the question of cryptocurrency liquidity.

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