Is the Crypto Market Hindered by a Lack of Liquidity?
To help you make informed decisions when investing in cryptocurrency, we’ve developed #CryptoInsights, a series of articles designed to give you all the information you need to optimise the value of your portfolio. If you have any questions about the #CryptoInsights, the Coinage Exchange or anything else Crypto related, feel free to get in touch with us.
The concept of liquidity is central to the financial marketplace, as it determines price volatility and dramatically impacts the risk profile associated with specific assets.
In short, liquidity refers to the extent to which a market allows assets to be bought and sold at enduringly stable prices, with lower levels typically resulting in greater volatility and more drastic value fluctuations. The crypto market offers a relevant case in point, with liquidity remaining relatively low on the majority of traded tokens and valuations tied to the fortunes of Bitcoin.
In this article, we’ll explore the lack of liquidity in the current crypto market, before considering how this impacts on investors and the execution of orders.
Why is there a Lack of Liquidity in the Crypto Market?
The lack of liquidity in the crypto market was recently explored in a report published by Diar, which drew on data recorded at Coinmarketcap on June 18th.
This revealed that the majority of trading volumes across more than 1600 crypto tokens were managed through the pairings of BTC, ETH, XRP, BCH and LTC, equating to 0.36% of all market activity.
This suggests that a small minority of market leading cryptocurrencies dominate the market as a whole, with BTC unsurprisingly central to this trend. In fact, 69% of the total trade volume recorded relied on Bitcoin, which enjoyed an historic price run in 2017only to lose an estimated 80% of this value during the first half of this year.
While these factors may hint at the lack of liquidity within the crypto market, however, why does this exist in the first place?
The primary reason is often referred to as the ‘double coincidence of wants’, which describes a transaction that only works when both parties are ready to exchange their respective goods or tokens.
The issue is that such a coincidence is decidedly rare, as it can be challenging to find two parties whose possessions mutually suit their others’ needs.
Sure, there are also individuals with assets to fulfil another’s demands, but connecting these in the same space and time is extremely difficult.
How Does this Impact on Investors?
Of course, some cryptocurrencies are marginally more liquid than others, especially those that boast high demand, low bid-spread asks and small price impact. Take Bitcoin, for example, which has a large market share and remains relatively easy to exchange for cash for alternative tokens.
In contrast, small or new crypto tokens that have minimal demand are often difficult to sell and convert into cash, which in turns creates lower liquidity levels that can impact negatively on the market and trigger significant price shifts.
Exchanges are going to continue to play a pivotal role in facilitating trade and increasing liquidity. They will have to work hard to create partnerships with liquidity partners, exchanges, market makers, issuers, wallet providers, institutions, funds and other market participants.
By tapping into multiple reserves and channels, minimising transaction fees and connecting various wallet providers, exchanges can make it easier to swap and sell tokens in real-time.
This will certainly empower investors who want to exchange or trade smaller cryptocurrencies, some of whom may have previously been deterred by the lack of liquidity within certain sections of the market.
The Last Word
While established cryptocurrencies such as Bitcoin boast relatively good liquidity, this is not true for the vast majority of tokens and huge swathes of the marketplace.
The overriding lack of liquidity in the market poses an issue, both in terms of increased volatility and the desire to establish cryptocurrency trading as a mainstream practice. This is why exchanges will play such a key role in the future, while the introduction of stablecoin pairings will also aid diversification and create one market per asset.
This will help to encourage and improve liquidity over time, and hopefully drive the widespread adoption of cryptocurrency in the financial marketplace.
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