In the financial market, liquidity refers to the ease with which an asset can be converted into cash without difficulty. Cryptocurrency liquidity is the ability for a coin to be easily converted into cash or other cryptocurrencies.
Cryptocurrencies and other tradable assets require liquidity. Market volatility results in a spike in cryptocurrency prices when liquidity levels are low. On the other hand, a high level of liquidity means that there is little price volatility.
In a liquid market, you can buy or sell cryptocurrencies more easily because buy and sell orders will be filled more quickly since there are more market participants. Due to the fast-paced nature of the cryptocurrency market, you can enter or exit a trade at any time.
Liquidity is an important concept to understand when dealing with cryptocurrencies. To define liquidity, it is essentially the ability of an asset to be converted into cash within a short period of time. A coin’s liquidity refers to its ability to be converted into cash or other currencies.
Liquidity: what makes it important? #
A marketplace with high liquidity is ideal as it results in improved prices for all parties involved as there are a lot of buyers and sellers. With a high level of trading activity, an equilibrium market price tends to be established that is acceptable for all.
Furthermore, high liquidity ensures that prices remain stable and are not subject to large swings resulting from large trades, which could affect cryptocurrency prices while increasing volatility for the general market. Because of the large number of market participants and their orders, prices on a liquid market are stable enough to withstand large orders.
In a liquid market, price and charting formation are more developed and precise, allowing for greater technical analysis accuracy.
Factors that Affect Liquidity #
Liquidity in the cryptocurrency market is affected by trading volumes. Check any cryptocurrency market cap ranking website to see daily volumes, as higher volumes indicate more people are buying and selling coins.
Due to a lack of information and clear guidelines by authorities, these activities have been limited to enthusiasts; however, interest in bitcoin trading and cryptocurrency trading in generally is attracting more people.
Since there is an increasing number of cryptocurrency exchanges, more people can trade their coins, and in recent years the number of exchanges has multiplied. More trading means better liquidity.
Liquidity is also influenced by usability. As cryptocurrencies are used more as a payment method, they become more liquid. This is why it is critical that merchants accept cryptocurrencies as a means of payment, in order to further boost the use of cryptocurrencies for transactions.
Last but not least, regulations are crucial. Cryptocurrencies have been banned in several countries, allowed in others and disputed in others. Even with the current situation, cryptocurrencies are rapidly growing, so a clear stance by the authorities on matters like consumer protection and taxation should result in more people getting involved, thus affecting the price.
For brokers to source the best liquidity provider, they need to assess their own needs and make an informed decision based on a number of factors.
How should you Choose a Liquidity Provider/ What to Consider? #
When looking for the right liquidity provider, brokers should consider several factors and assess their specific needs:
- The Offers – Primarily, a broker should pay attention to what assets are being offered and what kind of liquidity is being provided. In addition to providing multi-asset liquidity, FIX protocol access and historical data are essential from the liquidity provider. As well, all major stable tokens and cryptos should be accepted for deposit and withdrawal as well as a nominated account in different currencies.
- Market Depth – The depth of the market is another factor to consider. It tells us how liquid and deep a particular currency market is. Market depth is determined by the number of buy and sell orders at each price.
- Executions are fast – In times of high impact market news, liquidity providers must be able to provide fast trade executions with no slippage or re-quotes.
- Prices – The price offering of a liquidity provider should include competitive spreads as well as low commissions and swaps without compromise on either side.
- Data – A liquidity provider should be able to offer stable and reliable client data feeds. Prices must be obtained from all relevant exchanges as well as the interbank forex market in real-time. Delays in price data delivery may cause gaps.
- Its authenticity – In the same way that brokerage firms are regulated, liquidity providers should be as well. This will ensure they are following the industry’s best practices and that a prime broker is backing them up.
- Reporting – To comply with regulatory requirements, a liquidity provider should be able to provide an automated and robust reporting system. Trade reports, FIX bridge reporting, swaps and rollover reporting are typical reports.
- Software – FIX protocol and other APIs should be able to be implemented. MT4/MT5 bridge connections and FIX bridges should also be able to be implemented.
There are several factors one should look into when decided what is the best liquidity provider for their crypto. This will ultimately tell you how well a certain liquidity pool is being operated and whether you have enough chances to buy and/or sell your current cryptocurrency.
By following this guide, you ensure that you understand the main framework before putting your money into a project that does not provide enough liquidity for its holders. Otherwise, you run the risk of your assets being stuck.