Liquidity as a term is defined as the ability to buy or sell assets in the market without causing a radical change in the asset price.
Liquidity can refer to two different areas; Liquid markets (liquid markets) and liquid assets. Liquid markets mean that there are always investors in the market willing to trade. Liquid assets refer to assets that can be easily converted into cash.
But what does this mean when talking about cryptocurrencies?
Like any investment, you want to be able to buy and sell tokens quickly without having to put the price down or wait a long time for the trade to be matched. For this to be possible, the market you are trading must be liquid. In other words, there should be high trading activity and the bid and ask prices should not be too far apart.
Let's take an example from the seller's perspective.
Bob owns 5 tokens of a certain cryptocurrency and the price of his tokens has risen in the past few days. Bob is happy and decides to sell all his tokens quickly at the current market price.
If the market is liquid, this means that there are enough buyers who want to buy Bob's tokens for the price he is asking, so Bob can quickly sell his assets and sell them at the price he wants. Bob's trade will not affect the price of the token since there is enough liquidity in the market to absorb Bob's trading volume.
On the other hand, if Bob wants to sell his 5 tokens at the current market price and the market is illiquid or has low liquidity, which means that there are not enough buyers willing to pay the price Bob is asking for, he will have to lower his asking price or wait until the market becomes More liquid so he can sell his tokens. If Bob decides to sell at a lower price, his transaction will also affect the current market price of the token.
How to know if the market is liquid
When looking to see if a market is liquid or illiquid, it is a good idea to look at three important indicators. Trading volume within 24 hours, the depth of the order book and the amount by which the ask price exceeds the bid price, also known as the difference between the bid and ask prices.
Liquidity is extremely important when considering your trades. It is one of the main factors to enter or exit the market easily.
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