Liquidity can be considered as the measure of how easily a cryptocurrency can be traded with other cryptocurrencies. The more liquid a token is, the easier it becomes to trade it with other coins while getting the right price on your investment.
What Is Liquidity?
Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting its price. As mentioned earlier, it measures how easily an asset can be converted into cash.
Typically, cryptocurrencies with higher liquidity have larger trading volumes. This means that those assets will have plenty of buyers and sellers at any time, making it easier for you to get the right price when you sell your holdings.
Related Readings: Price Prediction For Bitcoin, Ethereum, and Ripple
How Is Liquidity Measured?
Liquidity is measured by calculating the bid-ask spread, which is the difference between the price a buyer is willing to purchase the asset for and the price at which a person is willing to sell the asset, also known as the ‘ask price’.
The size of the spread represents the asset’s transaction costs. The larger the bid-ask spread, the more time it would take for an investor to buy the token from a seller or a cryptocurrency exchange.
How Does Liquidity Help You When Trading Crypto?
Liquidity comes in handy when you want to choose the ideal cryptocurrency to trade, the most suitable exchange to trade on, or the best time to either buy or sell the token.
If there is low demand for a particular product or service offered by a blockchain, then the native cryptocurrency of the network will have low liquidity. The value of an illiquid asset is determined by how much people are willing to pay for it.
This becomes a problem if you want to sell a token in your possession that has low liquidity, because you may not be able to exit your position quickly due to poor market conditions. This could mean that you may incur losses by being forced to sell the asset at an available price.
Related Readings: What is Pre-Market Trading, and How Does it Work?
How To Check The Liquidity Of Your Crypto?
We now know that liquidity measures the number of people who are willing to trade a particular cryptocurrency. If a token has high liquidity, it means the demand for the asset is large and the market is pretty active.
Whereas, if a token has low liquidity, fewer people will be ready to buy the tokens, and those who want to sell it, do it at a loss just to exit their positions.
So, when you are considering investing in a cryptocurrency, there are a number of ways in which you can check the asset’s liquidity.
➡️Market Capitalization
This is considered to be one of the best ways to assess a crypto token’s liquidity. Market capitalization is the total value of all coins in circulation multiplied by their price per unit.
If a token has a high market cap, that means there is more demand for the crypto and people are willing to invest into it. It could also be an indication of more potential in the asset in terms of user base or investment preferences.
➡️Trading Volume
To determine how liquid a cryptocurrency is, all you need to do is take a look at its trading volume. A higher trading volume indicates more demand and that people are interested to buy or sell the asset to make a profit on their investment.
On the other hand, if a token has a low trading volume, then that means the general interest in the asset is low and it may end up being illiquid. This is also a risky situation wherein if something were to happen to the token’s market suddenly, like a pump or dump, then the coins may not have the same value as before.
➡️Token Distribution
Checking the token distribution of a cryptocurrency gives you an idea of how many people are currently holding it. If a small group of people hold most of the token, then it is not a good sign for its liquidity.
Whereas, if there are more people who invested varied amounts of money into the token, then that indicates more buy and sell activity and more liquidity for the asset. The more people holding a cryptocurrency, the more stable and less volatile its price will be.
Conclusion
The cryptocurrency market is a highly volatile environment where proper research is needed to ensure that your investment will be safe. You can use the aforementioned tips to rightfully invest in an asset by exploring the various aspects of its liquidity.
So, do your own research and invest responsibly.
