What is the liquidity of Bitcoin and cryptocurrencies?
Liquidity refers to the ease with which an asset or security can be converted into cash without affecting its market price.
Next, Bytwork will tell you why this is important, and what role understanding liquidity plays in the cryptocurrency market.
What is liquidity?
Liquidity shows how quickly you can buy or sell a certain asset on the market at the optimal price for it. Money is considered the most liquid asset because it can be converted into other assets most quickly and easily, wherever you are.
Tangible assets such as real estate, luxury cars, art and collectibles are relatively illiquid. Other financial assets, from stocks to partner shares, occupy different places in the liquidity spectrum.
Imagine that you need a camera for $ 1,000. Money is the asset that is easiest to use to acquire it.
If you don't have money, but have a collection of antiques valued at $ 1,000, you are unlikely to find someone who is willing to exchange a camera for your collection.
Instead, you'll have to sell the collection and use the cash to buy a camera. You may have to wait months or even years before you can sell your collection and make the right purchase. But what if you only have a few days? You may have to sell the collection at a discount instead of waiting for a buyer who is willing to pay the full price. Rare antique items are an example of an illiquid asset.
In cryptocurrencies, the concept of liquidity means the ability to quickly sell or buy digital coins. So, Bitcoin is considered the most liquid crypto asset – there are many exchanges where it is traded, it can be sold or purchased at a bargain price at any time. There are examples of rarer cryptocurrencies and tokens, for the sale and purchase of which there may not be enough volumes. In order to provide liquidity for such small assets, liquidity pools are created.
There are two main indicators of liquidity:
- Market liquidity is the ability of the market (for example, the stock market of a country or the real estate market of a city) to buy and sell assets at stable transparent prices. In the example above, the market for cameras in exchange for antiques is so illiquid that it practically does not exist. The stock market, on the other hand, is characterized by higher liquidity. If there is a large volume of trading on the stock exchange, which is not dominated by sales, the price that the buyer offers per share (bid) and the price that the seller is willing to accept (desired price) will be quite close to each other. Thus, investors will not have to give up unrealized profits for the sake of a quick sale. When the difference between the purchase and sale prices increases, the market becomes more illiquid. Real estate markets are usually much less liquid than stock markets. The liquidity of markets for other assets, such as derivatives, contracts, currencies or commodities, often depends on their size and the number of existing open exchanges on which to trade.
- Accounting liquidity refers to the ease with which an individual or a company can fulfill its financial obligations with the help of liquid assets available to it – the ability to repay debts when they mature. In the example above, the antiques collector's assets are relatively illiquid and probably won't be worth their full $1,000 value. From an investment point of view, the assessment of accounting liquidity means comparing liquid assets with current or financial liabilities that mature within one year. There are a number of coefficients measuring the liquidity of accounting, which differ in how strictly they define "liquid assets". Analysts and investors use them to identify companies with high liquidity.
Liquidity is important for any tradable asset, including cryptocurrency. Liquid markets are more extensive, while an illiquid market can put traders in positions that are difficult to exit. For example, the daily trading volume of Bitcoin. Over the past couple of years, BTC trading volume has grown significantly, reaching $81 billion at its peak.
For comparison, the daily trading volume of BTC in 2014 was less than $ 100 million per day, and sometimes fell below 10 million. By the beginning of 2018, this number exceeded $ 20 billion, and in February it broke all records, exceeding $ 80 billion. Let's look at the main factors affecting the liquidity of Bitcoin.
Increasing the number of reliable crypto exchanges will enable more people to trade their digital assets. An increase in the frequency and volume of trading contributes to an increase in liquidity. As popular exchanges become more secure, the number of buyers and sellers increases.
The adoption of cryptocurrencies to pay for goods and services will increase the convenience of their use and reduce volatility. The more Bitcoin is used as a medium of exchange, the more liquid it becomes.
Retailers periodically "accept" BTC for payment, but high speculative demand prevents its use in trading. In addition, the use of bitcoins in retail transactions has suffered from negative publicity related to the collapse of prices in 2017-2018, as well as cryptocurrency fraud.
ATMs and payment cards
The network of ATMs with cryptocurrency continues to expand, despite strong price fluctuations. Cryptomats are of great importance for wider acceptance, as they also facilitate the purchase of bitcoins. Many people do not feel comfortable using online exchangers, so ATM terminals are an excellent resource in such cases. Minus – this way of making purchases is much more expensive than online exchange.
In addition to ATMs, debit and credit cards are becoming increasingly important in the cryptocurrency world. These cards simplify transactions and purchases. The launch of payment cards and ATMs with the transfer of BTC to cash increases the usability and acceptance of cryptocurrencies. Purchases and withdrawals at the market price contribute to increased liquidity while maintaining security.
Regulation directly or indirectly plays a crucial role. The position of countries in relation to Bitcoin is as different as the countries themselves. In some it is prohibited, in some it is allowed. The authorities of many countries are monitoring the situation and many are even already working on the rules.
Despite the ambiguity on this front, the virtual currency is becoming more popular at a rapid pace. The presence of Bitcoin in the form of ATMs, exchanges, transactions in stores, online services and other places is growing. A clear position of the authorities on issues such as consumer protection and taxation may attract more people to open Bitcoin trading, which will affect its liquidity.
Many people may have heard the word "bitcoin", but do not know what a cryptocurrency is and how it works. There are many potential buyers, investors and traders among these people.
Poor knowledge and lack of clear instructions from the authorities limited the widespread use of cryptocurrencies during the first decade of their existence. As the world of cryptocurrency expands, more and more people are learning and starting to work with digital coins.
Liquidity refers to the ease with which an asset or stock can be exchanged for real money, without affecting its market price. Money is the most liquid asset, unlike tangible objects, which are less liquid.
The two main types of liquidity include market liquidity and accounting liquidity. Bitcoin is incredibly volatile, the problem of liquidity is one of the many factors that lead to sharp fluctuations in the price of cryptocurrencies. Strengthening liquidity will help reduce cryptocurrency risks.