Today, we’re discussing Liquidity. What do you mean by Liquidity? good liquidity & Bad liquidity And more…
Liquidity is how easy it is for you to convert an asset into cash or another asset, without affecting the current market price.
Good Liquidity: Low impact on price
Bad Liquidity: Big impact on price
The word Liquidity comes from the word liquid, as we know liquids are always free flowing and can change depending on the environment around them, think about your assets in the same way, the more Liquid your asset is the easier you can move it around (buy and sell), if your asset becomes less liquid like an ice cube your asset becomes harder to move around.
A lot of times you may see a coin on multiple exchanges, and the trading volume on each exchange is different; this is usually down to how good the liquidity is on that particular exchange, better liquidity will attract more trading volume.
Orderbooks and Liquidity:
Exchanges that run on an orderbook need large trading volumes to make sure the user experience is good, meaning a user can sell at the market price and the order can be filled relatively quick.
The bid-ask spread is very important in the marketplace. It’s the difference between the buyer’s and seller’s prices; what the buyer is willing to pay for something versus what the seller is willing to get.
If the prices are close together, it means the two parties have a similar opinion. However if the price difference is wider, that means they don’t see eye to eye.
There are different factors that effect the size of the spread.
The most evident factor is a pairs liquidity.
This refers to the volume or number of shares traded on a daily basis.
Some pairs are traded regularly while others are only traded a few times a day.
The pairs that have large trading volumes will have narrower bid-ask spreads than those that are infrequently traded.
When a pair has a low trading volume, it is considered illiquid because it is not easily converted to another asset.
Another important aspect that affects the bid-ask spread is volatility.
Volatility usually increases during periods of rapid market decline or advancement.
At these times, the bid-ask spread is much wider because market makers want to take advantage of and profit from it.
When pairs are increasing in value, investors are willing to pay more, giving market makers the opportunity to charge higher premiums.
When volatility is low, and uncertainty and risk are at a minimum, the bid-ask spread is narrow.
Higher demand and tighter supply will mean a lower spread.
Bid to Ask spread example:
The spread is the difference between the,
Lowest Sell and Highest Buy
Lowest Sell:
The lowest price a trader is willing to sell the particular asset for
Highest buy:
The highest price a trader is willing to pay for the particular asset
Eg. A seller is trying to sell his tokens in a Low Liquidity (Illiquid) Market.
The lowest sell is $110
The highest buy is $90
Spread = $110 – $90 = $20
The market price is $100 as the price converges to the middle point.
The trader puts a limit order to sell his tokens at $100.
But the trader can’t sell at $100 as the liquidity is very low so no one is willing to buy the tokens at that price.
So the trader has to compromise and sell at a lower price or wait for a while until the market moves up to their desired price.
