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  1. 1. What is liquidity?
  2. 2. The meaning of liquidity
  3. 3. The importance of liquidity
  4. 4. Three factors affecting liquidity
  5. 5. Ways to check liquidity of cryptocurrencies
  6. 6. What are Liquidity Pool and Liquidity Mining?
  7. 7. Conclusion

1. What is liquidity?

Liquidity is the metric used to describe how easy it is to buy or sell an asset in the market without affecting the price stability of that asset. In the cryptocurrency market, liquidity refers to the ability of a cryptocurrency to be easily converted into cash or another cryptocurrency.

Liquidity is a concept not only used in the cryptocurrency market, but also in the stock market, or any traded asset. An asset is considered liquid when it can be sold quickly without the price falling significantly as intended. For example: BTC, ETH,..

2. The meaning of liquidity

Just like any other market, if you want to be able to buy or sell cryptocurrencies quickly without having to reduce prices or spend time waiting for deals to be matched then the market you are trading in must be liquid. In other words, the market should have a lot of trading activities and the difference between the bid and ask prices should not be too large.

If you buy an illiquid cryptocurrency, it will be difficult to sell because there are almost no buyers. Even when the price of the cryptocurrency increases, if the liquidity is poor, you will not be able to make profits. If the price of cryptocurrencies falls, it will be even more dire, because the liquidity is even worse now and it is almost impossible to sell. As a result, the value of your property is decreasing day by day. This is why you should basically trade cryptocurrencies with good liquidity.

3. The importance of liquidity

  • Price improvement
  • Market stabilization, elimination of manipulations
  • Faster transaction times
  • Increased accuracy of technical analysis

4. Three factors affecting liquidity

  • Popularity of the project: This shows how much or little the community's interest in the cryptocurrency is. Usually, the more popular a cryptocurrency is, the more people trade it.
  • Usability and Acceptance: The existence of a currency is determined by community acceptance everywhere, because of the utility it can bring. That is why cryptocurrency must be accepted as a means of payment to increase its usability and liquidity.
  • Reputation of the project: Not all reputable projects have high liquidity, but for the most part, projects with great prestige will also have abundant liquidity. This is quite understandable, because if a project is proven to be serious, the community will also pay more attention to it.

5. Ways to check liquidity of cryptocurrencies

Before deciding to trade a certain cryptocurrency, you should check its liquidity by looking at the following 3 factors:

  • Trading volume in 24 hours.
  • Order book depth: at each price, how much is the volume to buy and sell?
  • The difference between the bid-ask (buy-sell) price.

6. What are Liquidity Pool and Liquidity Mining?

  • Liquidity Pool refers to the liquidity "pools" of AMM exchanges, or Lending projects, where users deposit assets into it as liquidity for others to trade. And to encourage users to deposit assets, projects will have incentives such as deducting a part of the transaction fee for them, giving more project tokens to users who provide liquidity, etc.
  • The act of depositing assets is called Liquidity Mining, aka liquidity incentives. The purpose of Liquidity Mining is to attract more liquidity to AMM, so that large value transactions do not slip much; or if it is a Lending project, encourage users to participate in borrowing.

7. Conclusion

Liquidity is always an extremely important factor in any market. Without good liquidity it will be very difficult to grow for that market.

Cryptocurrencies are known for being highly volatile assets. Therefore, the liquidity in this market is also often unstable. An illiquid coin can turn out to be a liquid, and a liquid cryptocurrency can also become illiquid due to various factors. It should be understood that this is the driving force for the market, and even factors like time of day have an effect on the liquidity of a cryptocurrency.

While not always completely safe, liquidity is still a very important factor when you participate in any market. Therefore, before deciding to invest, you should consider liquidity first and foremost.

Published on February 27, 2022

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