Cryptocurrency liquidity: the foundation that determines whether a token will live
What is cryptocurrency liquidity?
Cryptocurrency liquidity determines how easily and quickly a user can exchange an asset at a price close to the market price. An asset that can be quickly and without difficulties exchanged on any available exchange is called liquid.
Examples of the most liquid assets include Bitcoin (BTC) and major altcoins such as Ethereum (ETH), XRP (XRP), BNB (BNB), and Solana (SOL). These assets can be found on almost any trading platform. Some of these assets' daily trading volumes reach tens of billions of dollars — this is one of the leading indicators of high cryptocurrency liquidity.
What determines cryptocurrency liquidity, and what factors affect it?
At the moment when a crypto asset appears on a centralized or decentralized exchange, initial liquidity is formed, which can increase or decrease.
Cryptocurrency liquidity is not measured in specific units; rather, it is defined as a set of market data. Many factors affect cryptocurrency liquidity, including positive asset dynamics and metrics such as network activity and inflows into crypto funds (ETFs). Other factors are also no less important, such as:
- the number of exchanges on which trading of a specific asset is available
- the presence of large liquidity providers
- macroeconomic background and regulatory environment in financial markets
- a wide variety of trading pairs on different platforms
- a developed ecosystem, including in the decentralized finance (DeFi) market
Several parameters, including trading volume, spread size, market depth, and volatility, can be used to measure cryptocurrency liquidity.
Trading volume
Trading volume shows how much value of an asset was bought and sold over a specific period, for example, the last day or week. High trading volume is directly related to the demand for the asset. And the more popular the asset is among investors and traders, the higher the cryptocurrency liquidity on the market.
Trading volume data is available both on trading platform websites and on specialized monitoring resources such as CoinMarketCap and TradingView.
Market depth
The number and amount of orders* on exchanges determine market depth. The greater the market depth, the higher the cryptocurrency liquidity. Large trading volumes attract speculators, including arbitrage traders and scalpers*, who increase the total amount and number of orders on trading platforms.
* Order — an exchange request from a trader to buy or sell cryptocurrency.
* Scalper — a trader who earns on tiny price fluctuations, making a large number of ultra-short-term intraday trades, fixing small profits from each price movement.
As a result, traders have sufficient liquidity to quickly exchange even large amounts of cryptocurrency without a significant impact on the asset's price. If the market depth is small, even small sums can significantly affect the asset price and launch a chain reaction of pump and dump. In exchanges, market depth is often displayed as diagrams showing buy (bid) and sell (ask) orders.
Volatility
This indicator reflects how quickly and by how much the prices of digital assets can change over a specific period. The cryptocurrency market is very young compared to the stock and currency markets, so even the most liquid digital assets are very volatile.
Price movements on charts can determine the volatility of an asset. For example, charts show that the price of the largest cryptocurrency, BTC, can rise or fall by more than 10% in a single day. Altcoins over the same period can show even stronger growth or decline, by 50% or even more.
This is because altcoins are much less liquid compared to Bitcoin. Accordingly, the higher the cryptocurrency liquidity, the lower its volatility.
But this does not mean that Bitcoin is a low-liquidity asset. According to CompaniesMarketCap, the leading cryptocurrency ranks among the ten most capitalized assets in the world, alongside shares of the largest technology companies.
Spread
The spread is the difference between the buy and sell prices of cryptocurrency in orders placed on exchanges. With high liquidity and considerable market depth, order books are densely filled, reducing the spread.
The higher the cryptocurrency liquidity, the smaller the spread. And with a lower spread, cryptocurrency volatility decreases. High-liquidity assets have spreads of tenths of a percent relative to price on major exchanges, while low-liquidity assets can reach 15–30%.
How does cryptocurrency liquidity affect the market?
For individual market participants, cryptocurrency liquidity has different meanings. For some players, low liquidity represents a high risk, and for others, great opportunities.
At the same time, when assessing cryptocurrency liquidity, it is essential to consider other indicators, such as the market data ratio. For example, Bitcoin is the most capitalized asset in the crypto market, but the stablecoin USDT has almost twice the trading volume, while its market capitalization is about 80% lower.
Cryptocurrency liquidity provides high transaction speeds and the exchange of assets at prices as close to market prices as possible. Also, it reduces risks during exchanges associated with delays in order execution and unexpected losses during a sharp rate change.
It is essential to understand that overall high cryptocurrency liquidity does not mean high liquidity on a specific exchange. For example, the market depth of one of the most famous meme coins, Shiba Inu, on the largest centralized exchanges — Binance, Coinbase, and OKX — ranges from $300,000 to $450,000. At the same time, on one of the leading decentralized exchanges, Uniswap, this figure is only a few tens of thousands of dollars, indicating low liquidity in cryptocurrencies.