Markets
The importance of liquidity in the cryptocurrency market
In the cryptocurrency market, liquidity is a very important parameter.
Of all the parameters, in fact, it is the one that can individually have the greatest impact on prices, in addition to individual events of systemic importance.
The role of liquidity in financial markets
With the term “liquidity” we refer to those assets that can be exchanged on the market with extreme ease and speed.
The most liquid instrument of all is money, also because it was created specifically to be easily exchangeable extremely quickly.
There are also assets that are extremely difficult to sell, such as those that are locked until a certain date.
The more easily and quickly an asset can be sold, the more liquid it is considered, so there are different degrees of liquidity.
Money is the most liquid asset that exists, while physical gold, for example, is a little less liquid. A property by its nature is not very liquid, because it takes time to sell it, while some assets can even be totally illiquid if they cannot be spent (such as foreclosed funds).
In the financial markets, in general, the assets that are exchanged are liquid, with the exception of those that cannot be transferred because they are tied.
But even in financial markets there are different degrees of liquidity.
In particular, when we talk about financial markets with real liquidity, we mean money and those assets that are nothing more than different highly liquid forms of money.
In other words, in financial markets, liquidity simply consists of the most liquid assets. These include cash, both in physical and digital form, and those very short-term investments considered equivalent to cash.
Liquidity in the cryptocurrency market
The crypto market it is exclusively a portion of the general financial market.
So it also applies to traditional financial markets cryptocurrency marketsregarding liquidity.
What changes, however, are precisely the assets considered liquid in the crypto market.
Just like in traditional financial markets, in the cryptocurrency market an important part of the liquidity is made up of fiat money.
However, contrary to what is commonly thought, fiat money is not the most easily and quickly moved on the cryptocurrency markets.
For example, withdrawing or depositing fiat currency on exchanges takes from a few minutes to a few days, while with other assets the movement is simpler and faster.
Thus on the crypto market most of the liquidity is made up of tokens that replicate fiat currencies, i.e. the so-called stable currency.
To be sure, there are also stablecoins that are not pegged to fiat currencies, such as tokenized gold, but nowadays the term stablecoin is often used synonymously with tokenized fiat currencies.
The majority of liquidity in cryptocurrency markets consists of tokenized fiat currencies, or stablecoins, with fiat money in second place. In third place are algorithmic stablecoins, while any other form of liquidity in the cryptocurrency markets is practically absent.
How liquidity moves
In financial markets, the most important thing about liquidity is not the quantity present, but the speed with which it is exchanged.
For example, if a billion dollars were traded only once a day, it would have less of an impact than a million dollars traded more than ten times a day.
Sudden liquidity movements that move from one asset to another are the real culprits of price volatility.
In general, however, when it comes to long-term price trends, the overall change in liquidity matters a lot. For example, between 2020 and 2021, when the Fed injected more dollars into financial markets in less than two years than the 2019 total, the result was a generic, sharp and sudden increase in all prices.
In other words, the increase in liquidity tends to generate inflation, because it actually triggers an increase in purchasing demand.
Therefore, in the medium to long term, changes in overall liquidity matter a lot, while in the short term the speed with which it moves matters more.
For example, cash held idle in a bank account does not generate the slightest volatility in financial markets, while if it is spent to purchase financial assets it can generate an increase in prices.
The current situation of cryptocurrencies: market and liquidity
One piece of data that can help understand the current level of liquidity in the cryptocurrency markets is the trading volumes in stablecoins.
Among other things, it should be underlined that practically every day the cryptocurrency that records the highest trading volumes is USDT, which is by far one of the most liquid.
Typically, the daily trading volumes of USDT on the crypto markets (around 100 billion dollars) are double compared to that of Bitcoin And Ethereum (both around 50 billion), and approximately 10 times higher than those of the second largest stablecoin, USDT (10 billion).
On traditional financial markets, the overall trading volume of USD is enormously higher, so much so that for example the single Nvidia stock is recording daily trading volumes not far from those of USDT on the crypto markets, and almost double those of Bitcoin or of Ethereum.
Taking the overall trading volumes of all cryptocurrencies as a reference, the cryptocurrency market has been recording a daily trading volume of more than 100 billion dollars in recent days, but at the beginning of May it was only 70.
During the peak in mid-March they had risen to 150, well below the all-time high of $300 billion traded on, for example, April 19, 2021.
In other words, the liquidity circulating in the cryptocurrency markets actually varies from day to day, albeit with not exaggerated variations, but above all varies from period to period, with large jumps during the bullrun, and strong contractions during the bear market.
It should be noted that these variations not only affect volatility but also prices, and it is precisely for this reason that when there is less liquidity prices tend to be low, while when liquidity increases prices also tend to increase.