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When we talk about the liquidity of a cryptocurrency we refer to the ease with which we can exchange it for cash or any other cryptocurrency without any difficulty.
Basically, this is a feature of the markets that allows us to recognize whether we can buy or sell a cryptocurrency quickly and smoothly in the market.
Liquid or highly liquid markets are the ones that receive more users, since they encounter fewer setbacks to carry out their operations. Liquidity increases the interaction of the parties and there is greater dynamism, unlike in illiquid markets.
Importance of liquidity in the markets
The importance of liquidity encompasses all tradable assets, including cryptocurrencies. A market with liquidity can be called a “healthy” market, as low levels of liquidity are a symbol of volatility and cause noticeable spikes in cryptocurrency prices.
On the other hand, if there is high market liquidity, the market is stable with little price variation. Clearly, all markets seek to achieve this liquidity. This is why there are companies called Market Makers. By purchasing the services of these companies, they are in charge of creating liquid order books and a large exchange volume.
Clearly, it is much easier to buy and sell cryptocurrencies in a liquid market, as user orders for buying and selling cryptocurrencies will be executed much faster thanks to a larger number of market participants.
If this happens, it implies the possibility of entering and exiting any trade at any time.this means that liquidity is linked to the supply and demand of the market with supply being the amount of asset available to trade and demand being the needs of traders to exchange their assets for others or convert them into FIAT.
How liquid is an asset?
The assets we trade or buy may be more or less liquid and therefore some may trade more easily. When we talk about a liquid market we usually confuse it with a dynamic market or with a higher volume of exchanges than the rest.
If a market has a volume of 10 million euros and it is traded every 10 seconds with an average transaction of 1000 € it does not mean that it is liquid, in fact it may simply be a market with the Market Making strategy implemented.
If we want to know how liquid a market is, we only have to look for the Order Book and observe how the price of an asset behaves when an order is placed with respect to it. If at the time of sending an order, for example, BTC-Euros, the price of Bitcoin changes a lot, it is a market with low liquidity.
In this case, the operation may never be fully completed due to the lack of assets to carry out the operation.
Classification of assets according to their liquidity
Assets can be classified according to their liquidity as follows:
1- FIAT money: all transactions and services with FIAT (euros, dollars, yuan, etc.) such as loans, sales, bank deposits, debts. FIAT money is the most liquid asset par excellence.
2- Metals such as iron, bauxite or copper and precious metals such as gold and silver.
3- They are followed by currency markets including stock indexes and ETFs.
4- Lastly, there are cryptocurrencies.