As a result, calculating the exact liquidity of the exchange or market is difficult. However, there are other signs that can be used as proxies for liquidity in cryptocurrencies. A greater trading volume for the coin pair means that there are lots of sellers and buyers that are interested to trade the coin pair. It is not recommended to trade obscure coin pairs which have limited popularity and trading volume can impair your investment positions.

How Is Crypto Liquidity Measured

5Foley et al. report that, as of July 2018, there are over 1800 cryptocurrencies available, whose combined market capitalization exceeded $300 billion. Various online cryptocurrency markets and exchanges trade around $50 billion every day. One risk of investing in crypto during a liquidity crisis is that the market may become over-saturated with sell orders, which can create large price swings and volatility.

Guide to Cryptocurrency Liquidity: How to Measure Liquidity & Trade Well

They “make the market” by ensuring that traders can always buy and sell. This is done by actively quoting both sides of the market and providing bids and offers. Highly liquid markets enable frictionless entry and exit from positions at a fair price. This is because a busy market makes it easier to find buyers or sellers on the other side of a trade. The measures that perform best in the cross-sectional analysis are the Amihud illiquidity ratio and the Kyle and Obizhaeva estimator because they do well at all data frequencies and for both currency pairs.

How Is Crypto Liquidity Measured

This helps to prevent over-leveraging and ensures that liquidity is maintained even during periods of high demand. As crypto markets become more mature, we can expect exchanges to continue developing better mechanisms for dealing with liquidity crises. Ultimately, this will help to make cryptocurrency investing a safer, more predictable activity.

An entire market can be said to be liquid, as well as a particular trading pair within a market. For example, US stock markets are considered to be the most liquid of any such markets in the world. Within a US stock market such as Nasdaq, some stocks are more liquid than others. More popular cryptoasset pairs like Bitcoin – Tether (BTC/USDT) or Ethereum – Tether (ETH/USDT) have better liquidity than lesser known pairs.

CoinGecko’s measures

Although it’s always good to have cash on hand, holding too much cash can be a negative factor for a company’s long-term growth prospects. As the name suggests, analysts solely look at how much cash a business has versus its liabilities. Even if a company holds many assets it can convert to money, it won’t factor into this equation. The current ratio gives investors a broad overview of a company’s financial health.

An occurrence that most traders definitely do not like to see while trading is slippage. Slippage occurs when the bid-ask spread for an asset changes between the moment when a market order is placed and when that order is processed. Furthermore, larger market orders frequently have higher slippage since they need more liquidity in order to be fulfilled.

Example of Crypto Liquidity

Figure6 shows that liquidity connectedness is higher in the short run than in the medium and long run. Although we observe a similar time-varying pattern for all frequency domains, some exceptions exist. For example, from the start of the sample period to early 2017, all frequency domains show a similar downward trend.

Since money can be transferred more quickly than other assets and is always accessible, liquidity is essential for all assets. In addition to all that, having access to competitive cryptocurrency exchange markets with solid liquidity encourages investors and businesses to sell their reserves with minimal or no value loss. Because liquid assets see large trading volumes, increased liquidity makes it simpler for market players to spot possible market trends. This information is especially beneficial to traders who rely on technical indicators to guide their trades.

What is market depth?

Volume can indicate the direction and movements of the current market trend. Greater trading volume equates to more trading activity and is therefore a liquid market. Additionally, a higher volume backing a market trend – either a decrease or increase in cryptocurrency prices – signifies higher market activity backing the overall trend. For example, a drop with considerable volume behind it might mean a coin is in for an extended bear run. If price movements are not backed by volume, this would however indicate that only a small number of people are backing the current price trend and therefore, it may be short-lived.

This goes to show that looking only at the liquidity of an exchange is insufficient; you have to ultimately look at the liquidity of the specific coin pair that you’re interested to trade on. Projects with high liquidity are more stable because plenty of buyers and sellers are trading in the market. As such, the price of the asset will be less affected by a single trade.

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  • Institutions are expected to require more stringent KYC/AML procedures before investing, which could further decrease liquidity.
  • In other words, it is a measure of the number of buyers and sellers present and how easily transactions can be completed.
  • The narrower the spread, the more liquid a cryptocurrency is said to be.
  • Market depth represents the ability of a market to absorb large market orders without impacting the price significantly.
  • This phenomenon has not only made these markets more liquid but also given rise to potentially synchronized liquidity swings.

This makes it hard for investors to assess the risk-reward ratio of any investment they make, making it more difficult to plan their portfolio strategies. While these are just some of the factors contributing to liquidity issues in the crypto industry, there are steps that market participants can take to help minimize their effects. For example, exchanges and businesses can continue to advocate for increased regulation and greater institutional investment, which can help stabilize crypto markets and reduce the risk of market manipulation.


We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator.

The first and emerging strand of literature that looks at liquidity in the cryptocurrency market has not emphasized the connectedness of liquidity among these markets. Kim and Dyhrberg et al. suggested that BTC’s attractiveness for retail trading lies in its lower transaction costs. By implementing different low-frequency liquidity indicators, the author found that BTC’s liquidity is typically lower than stocks and that liquidity differs throughout exchanges. Similarly, Smales suggested that the liquidity for BTC is lower than other safe-haven investments, such as gold. Considering different sets of cryptocurrencies, Brauneis and Mestel and Wei indicated a positive relationship between liquidity and price efficiency . Koutmos developed a proxy for liquidity uncertainty by relating it to the market features and trading activity of BTC.

What is Crypto Spot Liquidity: Definition & Explanation

We first apply the spillover model of Diebold and Yilmaz to compute the liquidity connectedness across our sample cryptocurrencies. Moreover, we implement the connectedness framework of Baruník and Křehlík to further explore the time–frequency domain aspect of liquidity connectedness. Provides a summary of all those works.6 A key message from these studies is that cryptocurrency markets become increasingly interconnected over time regarding their returns and volatilities.

This helps ensure that trading remains active even during periods of low liquidity, which can help prevent panic selling and other negative effects. One of the main causes of liquidity problems in crypto is regulatory uncertainty. As cryptocurrencies are still a relatively new technology, governments and financial regulators around the world have been how to find liquidity provider slow to adapt to this new paradigm. As a result, some key regulatory decisions impacting crypto businesses and exchanges are still being made, which can create confusion and uncertainty around how these businesses should operate. In addition to these factors, some experts believe that there is a lack of talent and expertise in the crypto space.

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When people talk about “liquidating assets,” they’re swapping their holdings into fiat currency. The longer it takes to convert an asset to ready money, the less liquid it is. Yield farming refers to lending or staking cryptocurrency in exchange for interest and other rewards. Yield farmers measure their returns in terms of annual percentage yields . Asymmetric information is a commonly studied factor involved in liquidity.

Assets with longer histories and more developed markets tend to be more liquid, due to there being a more robust ecosystem of supply, demand, and transparent information for these assets. This lesson centers on understanding cryptocurrency market capitalization. Bitcoin can be considered a real asset since it doesn’t depend on the price of others.