Crypto Glossary

Liquidity

Liquidity refers to the ease with which you can convert an asset back into cash (or sell it) without radically affecting the market price of that asset.

If something is said to be “liquid”, it means that it is relatively easy to sell back into cash without radically affecting it’s market value.

Examples of assets that are not very liquid would be real estate. While you can certainly sell your real estate, it isn’t necessarily fast nor easy to do. It takes time. For this reason, it is considered illiquid. Collectibles, art and other similar assets are also not very liquid. Yes, you can sell them, but it takes time. You’ve got to find a buyer and that, alone, can take time to do.

Other assets are much easier to sell and convert back to cash. A liquid asset is one that is easy and fast to convert back to cash. Most cryptocurrencies are pretty liquid since you can easily sell them on an exchange and convert into another currency – or even back into cash.

Liquidity also refers to the overall amount of capital flowing through a market. The more money that is flowing through a market, the easier it is to sell your assets when you wish to without radically affecting the overall market price. Bitcoin is a very liquid market because a lot of people are buying and selling it all the time. For this reason, it is very easy to sell your Bitcoin is you wish. Much smaller markets might have much less liquidity. Less liquidity in a market means less buyers and sellers, therefore it would be more difficult to sell your’s. And, for smaller markets, it is easier to affect the overall market price of the asset.

Liquidity, then, is a function of the overall size of the market and how much money is flowing through it. Bigger markets  have more liquidity and it is therefore easier to sell whenever you please. Smaller markets have less liquidity.

You will sometimes see the word liquidity applied to exchanges. Some exchanges have more available liquidity than others. Once again, exchange liquidity is would be a measurement of how much crypto you would be able to sell on that exchange without significant slippage. An exchange with a lot of liquidity means there is enough market activity on that exchange that you could sell a higher amount of crypto and it would not radically affect the price of the coin. On the flip side, if you wanted to try to sell a larger amount of coin on an exchange with lower liquidity, it is likely it would much more radically impact the price. Your transaction would likely need to be broken up into multiple trades and the price of each trade is likely to be different as the price drops on that marketplace. This is known as slippage.

Therefore, generally speaking, exchanges with more liquidity make better marketplaces. Especially if you are trying to buy/sell larger amounts of crypto.

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