Liquidity refers to those topics that will always be popular both in the crypto community and beyond. We are sure that there is no crypto enthusiast who has not heard about Bitcoin liquidity. But how to calculate liquidity and how to find the most liquid exchange? First things first.
Liquidity is a key parameter of an asset, which means its quick sale at the current cost. For example, traditional money has the greatest liquidity, since other assets can be purchased for them at the market price and at any time. But low liquid assets can be considered goods that are more difficult to sell. For example, works of art, real estate, jewelry, etc.
Thus, liquidity can be considered an opportunity to sell assets on the market without provoking sharp changes in their cost. Moreover, liquidity is inherent not only in assets but in the market as a whole. Let’s look at these areas and determine how liquidity affects trading activities within the cryptocurrency market.
Active participants, who make movements in the market, determine its liquidity. Moreover, an asset can be considered liquid if it can be converted simply into traditional funds.
At the same time, cryptocurrency liquidity is determined by a combination of factors such as the popularity and application. In other words, the greater its trading volume, as well as the higher the possibility of its use when buying/selling goods or services, the more this cryptocurrency is considered liquid.
The liquidity indicator is used by traders when building their trading strategies, as it helps to increase the chance of a correct price forecast. One of the things to understand is that in case of low liquidity, the asset is subject to sharp changes in the exchange rate, as well as slippage is often inherent in it. Thus, the trader risks losing potential profit.
How to spot the crypto asset liquidity?
To determine liquidity, you should pay attention to some factors:
Listing on exchanges
The asset presence on the trading platforms increases its liquidity. The more exchanges have listed an asset, the more opportunities for traders to operate it. So, the trade volume is increasing. But in general, new cryptocurrencies are characterized by low liquidity due to their non-presence on major exchanges.
Using outside the industry
Cryptocurrency liquidity is also affected by its use outside the cryptocurrency market. For example, when a virtual asset is accepted as payment for goods or services. Bitcoin is the most liquid virtual asset due to the fact that you can pay with it for hotels, for goods and it`s easy to buy it on all exchanges. That is, it has a wide scope, which indicates its high liquidity.
The stronger the crypto community scales, the more liquid the assets. This fact is undeniable, and the proof is the progress of Bitcoin after 2017 when this coin began to be especially popular with investors. Thus, its trade volume increased tenfold, and so far, Bitcoin is the most liquid asset in the market. However, if the cryptocurrency is new and a sufficient number of crypto enthusiasts have not yet heard about it, then the asset is considered to be low liquid. At the same time, the asset has every chance to change its position, drawing attention to it with marketing activities and constant development.
Price, daily volume, capitalization
You can calculate the approximate cryptocurrency liquidity using its rate, capitalization, and daily volume. High price and volume over the last 24h demonstrate the demand for an asset in the market. At the same time, having studied these indicators over several days, you can determine the trend and make an approximate forecast regarding the behavior of the currency in the future.
Based on the above factors and knowing how to analyze them, the trader will be able to make a more correct choice of a tool for making a forecast.
Cryptocurrency liquidity calculation
If we draw an analogy of the cryptocurrency market with the financial one, then we can note a certain difference in relation to the liquidity parameter. The fact is that in the financial analysis it is possible to calculate the liquidity coefficient. However, a specific formula doesn’t exist on the virtual asset market due to the many factors that we examined above affect the liquidity of cryptocurrencies.
In general, it is possible to calculate the approximate liquidity of an asset using capitalization and price indicators. To do this, divide the daily trading volume by the rate of the asset. The parameters of the rate and trading volume per day are used by traders to make a decision on the purchase of an asset, as well as to predict further price movements. A decrease in the parameter indicates the bearish trend (falling rate) approximation and vice versa.
As you noticed, calculating liquidity is not an easy process, which is why GoodCrypto provides its users with a Liquidity Checker. With this tool, you can find the most liquid exchange and trade your favorite pairs.
Cryptocurrency liquidity as an indicator of confidence
The liquidity of cryptocurrencies is undoubtedly an important parameter that you should pay attention to when building your trading activity. After all, liquidity determines, first of all, trust on the part of current and potential traders or investors.
Low liquid assets are often the subject of speculation and pumps and dumps. It is easier for fraudsters to influence the price by selling or buying a large number of coins. If unscrupulous market participants sell cryptocurrency in large volumes, a price drop occurs. They take advantage of this and buy up assets, and then wait for their price to rise and sell, thus getting the difference.
Attackers can also buy an asset in large volumes, thereby artificially raising the price, creating excitement around it. And as soon as the exchange rate reaches its peak value, a large number of coins/tokens will again be sharply released to the market, thereby exposing other participants (often beginners) to a loss of funds.
The choice of liquid exchange
The liquidity level is one of the main parameters by which the exchange should also be selected. We have already found out that liquidity demonstrates the activity of traders. Thus, a crypto exchange with a good liquidity indicator has a high trading volume. In turn, liquidity makes trading much faster and easier. At the same time, it is worth paying attention that the liquidity of trading depends on the geographical location and jurisdiction.
An example of the consequences of low liquidity is the collapse of XRP by almost 60% this winter. On the BitMEX exchange, as a result of an instant collapse of the exchange rate, the token at some point dropped to $ 0.13.
The reason for this fall was the low liquidity of the XRP/USD market, which BitMEX launched, depriving its traders of funds.
Choosing a cryptocurrency pair to trade
After analyzing the market and identifying current trends, traders need to choose the best trading pair.
In general, this is not difficult. First, you need to determine which pairs are the most popular. Traditionally, there are a lot of orders with crypto/USD pairs, and as for cryptocurrency pairs, the leading ones are BTC/ETH, BTC/LTC, USDT/BTC, and others.
This situation is taking into account the great demand for them – they are highly liquid assets. The greater the liquidity, the more opportunities open up on the market. Moreover, this indicator also affects the profit that you can get from each transaction.
Most traders prefer Bitcoin as the base cryptocurrency. We have already mentioned that this cryptocurrency meets all the factors of high liquidity – it is the most popular, it is simple to buy and it can be easily operated outside of trading activities.
Of course, Ethereum is also in great demand and is an excellent choice for trading pairs because of its popularity due to smart contracts.
We should also like to mention Tether as a basic cryptocurrency for many pairs. This asset is one of the most stable today, it is used all over the world, as its exchange rate is tied to USD, but at the same time, it has all the advantages of virtual currency.
The choice of the best trading pair also depends on the exchange on which you trade.
It is worth noting that in 2020 the cryptocurrency market became more massive. There is a tendency to use cryptocurrencies as methods of payment. For this reason, the market is becoming more stable and affordable.
It is not surprising that USDT is the cryptocurrency with the highest trading volume, and the pairs Tether/Bitcoin, Tether/Ethereum, Tether/Ripple, and Tether/EOS remain at the peak of popularity.
The EOS success is ensured by the latest updates, as a result of which its blockchain has become faster and safer.
It should also be noted the pairs with TRX. After Tron was recognized as one of the best content sharing platforms, the Tron Foundation acquired new investors and the price of TRX increased. The pairs TRX/BTC, TRX/XRP, and TRX/ETH are especially popular in the Asian market, so you can pay attention to them when trading on exchanges such as OKEx and Huobi.
Concluding that, liquidity is an important indicator when choosing an asset and a trading platform, of course. The more popular the cryptocurrency, the greater its volume and the less its exposure to volatility. At the same time, for a full analysis, you should carefully approach the choice of the exchange, as well as comprehensively use other methods. Only in this way you can develop your strategy and make the most accurate forecast.