Liquidity on crypto exchanges in 2020: Why It’s so important

1. What is liquidity?

When people talk about liquidity, what they generally mean is how easily a particular asset can be exchanged for another asset or money without sacrificing too much of its value. When applied to crypto exchanges, both aspects of this concept – the ease and the cost – are of utmost importance: as a trader, you want your order to be executed as quickly as possible, without costing you an arm and a leg.

The term is also used to denote "market liquidity" – that is, the overall strength of the market. To be able to buy or sell assets easily and cost-effectively, a trader wants to have a liquid market.

2. How does the concept apply to the crypto market?

In the context of the cryptocurrency market, liquidity refers to three different aspects: market liquidity, exchange liquidity, and asset liquidity. Market liquidity is the indicator of the overall health of the crypto market and it encompasses exchange liquidity – that is, the ease and transparency with which traders can operate on the platform – and asset liquidity, which is the ease of access to the particular digital currency on a specific exchange.

When choosing an exchange to trade on, it is important to be mindful of all of these three tiers, although the most important are the latter two, asset liquidity and exchange liquidity. Is the particular cryptocurrency pair the trader is interested in available on a given exchange? How easy and fast is the exchange to trade on? How fair are their fees? Are the trader's preferred trading strategies available on an exchange in question? These are all very important questions when researching an exchange to use.

3. Why should you pay attention to liquidity?

As we mentioned earlier, liquidity's primary purpose is to indicate the strength of a particular asset, exchange, or market. And the key to it is stability – the more liquidity there is in the market, the more stable it is. When placing a buy or sell order in one of the fundamental cryptocurrencies, one will always find willing buyers or sellers, and the resulting trade will not likely have a significant effect on the asset's price regardless of the scale of the transaction. On the other hand, when trading less common cryptocurrencies, you may have to look hard for buyers or sellers for your asset pair, and, consequently, this may impact the cost of your trade and increase the asset's volatility. A less stable asset is seen as less liquid, which in turn hurts the market liquidity.

Another factor that comes into play when choosing your crypto exchange is how well it protects you and other players from price manipulation. The crypto market is relatively new, and its legal regulation all over the globe can be murky and insufficient. With the introduction of KYC procedures on many exchanges the risks of deliberate price manipulation on the part of pseudo-anonymous actors are starting to go down, but to say that they are completely gone would simply be untrue. And the less liquid markets make it much easier for market players to manipulate the price to their advantage. And here it is vital to remember that the more liquid the exchange or the asset, the more manipulation-resistant it is.

The crypto market moves very fast, so transaction speed is critically important. On exchanges that have high liquidity and a larger trader community, your orders will go through much faster than on some smaller, less liquid exchanges. And that can have a huge impact on your trading bottom line.

To trade efficiently, many traders use specialized technical analysis tools. They allow them to track the market trends and movements to make better-informed trading decisions. The higher liquidity markets and exchanges tend to provide more accurate, finer-grained information than the ones with lower liquidity, and that can also help you trade successfully.

4. How to keep track of liquidity

When doing research on liquidity, a trader must examine the liquidity of a particular asset or exchange. According to this source, the three exchanges with the best liquidity are Binance, Huobi, and HitBTC. Another handy tool, Liquidity Book, allows traders to monitor the best liquidity for a specific transaction amount.

As you have learned by now, the crypto exchange's liquidity determines a trader's ability to sell or buy digital assets quickly, without sacrificing the value or impacting the price of the asset. High-liquidity exchanges enable market players to buy their target amount of crypto at the best price as quickly as possible. A liquid exchange is a healthy exchange, and that means better trading for traders large and small.