High liquidity: How Important is it for Profitable Trading?

January 3, 2020 11:58 AM UTC

New crypto traders often have to learn a lot of terms in order to get on board the crypto train and make the most out of it. One of the terms that confuses most newbies is liquidity. After mastering the concept of liquidity, traders are able to improve their bitcoin trading strategy, or at least have a better understanding of how crypto trading works.

Liquidity is not a new matter of importance for traders. In fact, it has existed as an important metric long before the arrival of digital money. It’s a fairly old concept used in economics. It has been a useful tool for creating the modern world economy. Let’s take a look at what liquidity really is, how it is used in relation to cryptocurrencies, and how it can help traders make profitable decisions.

What is liquidity?

Essentially, liquidity of an asset usually determines how quick it can be bought or sold. If liquidity is high, the asset can be exchanged for something else pretty quickly. On the other hand, if liquidity is low, then people seeking to exchange the asset might face difficulty.

So, what are the most liquid things in this world? Once you think of it, your thoughts should be directed at things that you can easily change for something else. Luckily for us, thousands of years, a Lydian king came up with the original idea to make a thing that would by default be considered most liquid. Currency.

If you have currency, you can go to any store and exchange cash for whatever you want. It’s just how things work nowadays. Currency has the best liquidity, especially the most stable currencies such as US dollars, which can be exchanged for virtually any good or service in most parts of the world.

Then, there are low liquidity assets. Imagine owning an old and valuable guitar and wanting to exchange it for something else. There wouldn’t be as many options as there are with currency, would there? This is where the difference between value and liquidity are highlighted. Many things of value cannot be redeemed for the underlying value with great ease. In the case highlighted here, you would first have to sell the guitar for currency and then use the newly acquired currency to buy the very thing you wanted to exchange your guitar for in the first place.

Cryptocurrencies & liquidity

Fiat currencies are considered the most liquid asset, and things are likely to remain so. However, when cryptocurrencies were created, they aimed to become a real game-changer. Yet, after more than a decade after the creation of Bitcoin, more cryptocurrencies still don’t have enough liquidity to be compared to fiat currencies. In order to achieve maximum liquidity, cryptocurrencies need to become a preferred medium for making payments, like fiat currencies. Although this is possible in the future, we still have to wait and see how things with cryptocurrencies would unfold.

While liquidity is important for purposes of consumption, it is equally important for trading. A critical short-term importance to traders in the liquidity of exchanges.

Online exchanges & Liquidity

Online cryptocurrency exchanges can also be a subject of liquidity.

How so? Simply put, once you register on an exchange, the platform needs to find another user who will be willing to trade with you. Should it fail to match the maker with the taker (and vice versa) you will have to wait a bit until it happens. In that case, it’s safe to say that you failed to exchange your asset as quickly as possible, which would be the case with cash purchases. Therefore, the problem might not even be in the cryptocurrencies you’re trying to exchange but in the exchange that you’re using.

Users who want to exchange one crypto for another need to take two things into account – that the exchange supports that trading pair, and that the exchange has enough users interesting in trading the two cryptocurrencies you want.

It’s fairly difficult for new exchanges, therefore, to immediately be effective, as they usually don’t have enough users. Those who register on new platforms would have to wait until they find a match.

That’s one of the reasons why you should always stick to popular crypto exchanges. Millions of users actively trading on them means you will always be able to make an exchange whenever you want as there will always be someone willing to take your offer.

How to find a Cryptocurrency Exchange of High Liquidity?

If you’re a new trader, you need one thing – a simple and intuitive exchange with high liquidity against fiat currencies. One such platform is CEX.IO, one of the oldest exchanges in the space. CEX has similar fiat liquidity as exchanges like Coinbase and Kraken, but CEX is made mainly for people who enjoy trading various kinds of cryptocurrencies and not just Bitcoin or ETH.

Other high liquidity exchanges but not tailored for fiat include Binance, OKEx, and Huobi. It’s important to note that a lot of exchanges fake volume so liquidity needs to be assessed with scrutiny.

High liquidity is Profitable as Cryptos are Volatile

We need to answer the following question – why do crypto traders need high liquidity? Waiting a bit won’t hurt anyone.

But here’s the problem – all cryptocurrencies are highly volatile as well. Volatility is how often the price of an asset changes, and as you probably already know, the BTC price and prices of other cryptos are changing every second. Therefore, trading cryptocurrencies needs to be almost instant in order to get the most of it. If a price suddenly drops or jumps, then your offer for exchange might prove too expensive or too cheap.

Conclusion: Pay Attention to all the Details

To sum up, trading cryptocurrencies is a dynamic and exciting activity. In order to master it, you need to learn about various terms used in the industry. Yet, your job doesn’t stop there. The road to becoming a professional trader is one full of obstacles and pitfalls which you need to successfully avoid by staying up to date with the latest technologies related to the industry.

Ultimately, you need to read the news regarding cryptocurrencies you trade in order to gain insight into possible price changes and take your actions accordingly. So, choose your cryptos and your exchanges wisely in order to maximize liquidity, but understand that it is only the first step towards becoming a trader of cryptocurrencies.

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