The term Liquidity defines the ability to buy or sell assets in the market without causing a drastic change in the price of the assets.

Liquidity can be classified into two different types; liquid market and asset liquidity.

In the liquid market, it means that there are always investors in the market willing to trade (buy or sell an asset). Asset liquidity refers to an asset that can be easily converted into cash.

  

But what does this mean when we talk about cryptocurrencies?

As with any investment, you want to be able to sell and buy tokens quickly, without needing to reduce your selling price or wait long for your order to be executed. For this to be possible, the market you are trading in needs to be liquid. In other words, there must be high trading activity and the buy and sell prices must not have a very large difference.


Let's take an example from a salesperson's point of view;

Bob has 5 tokens of a certain cryptocurrency and the price of his tokens has increased in recent days. Bob is happy and decides to sell all his tokens at the current market price.

If the market is liquid, it means there are buyers willing to buy Bob's tokens at the price he is selling, Bob is able to sell his assets at the price he wanted. Bob's trade does not affect the price of the token, as there is enough liquidity in the market to satisfy the sale Bob made.

However, if Bob wants to sell his 5 tokens at the current price and the market has no or low liquidity, which means there are not enough buyers willing to pay the price Bob wants to sell his assets, he is forced to lower the price desired selling price or wait until the market has more liquidity to sell your tokens. If Bob decides to sell his tokens at a lower price, his trading will affect the current market price of the token.

  

How to know if the market has liquidity

To check whether the market is liquid, it is necessary to analyze three important indicators. The trading volume in the last 24 hours, the number of offers in the Order Book and the difference between the selling and buying prices, also known as the Bid/Ask Spread - the difference in the market between the ask ( best sell) and the bid (best buy).

However, the order book is not always an accurate representation due to strategies such as Stop-Limit (automated orders that you can set buy and sell values ​​for) and Iceberg Orders (large orders that have been split into smaller orders), which are created with the use of automation and, as a result, do not always appear in the order book until pre-programmed conditions are met for those orders.

Liquidity is extremely important when considering your trades. It is a key factor in entering or exiting the market easily.

Stay tuned for more content and remember to watch our other videos on Binance Academy.