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Why is liquidity important to your crypto investment?

The crypto market is a large one. It parades thousands of cryptocurrencies or crypto assets, including bitcoin which dominates the crypto market by over 40%. Due to the influx of various blockchain & crypto innovations as well as the growth of adopters daily and globally, the crypto market is expected to grow beyond its current value. Currently, the crypto market capitalization is over $2billion. 

As described here, liquidity simply describes the ease with which an asset can be readily converted into cash without affecting its price. 

Crypto investment
Photo by Ljubljana, Slovenia

Now there are numerous benefits you can gain if the assets in your crypto investments are liquid. In the same way, if the assets in your crypto investments are illiquid, you stand the risk of loss. 

Five (5) major reasons why liquidity is important to your crypto investment

Below, let’s look at five (5) major reasons why liquidity is important to your crypto investment:

  1. Fair prices: When there is high trading activity or there is a large number of traders in the market, this helps to boost liquidity, resulting in fair prices for everyone. This is because sellers will sell their assets at more competitive prices and buyers would be more willing to put their money in.
  2. Stable market: The more liquid an asset is, the more stable its price is. Conversely, the price of a less liquid asset is likely to experience serious fluctuations especially when a single large trade is made. As an investor, you do not want to be holding assets with less liquidity except you are ready to lose money. A less liquid cryptocurrency most likely means that there are few holders, amongst whom one person could own 50% of its supply. If he decides to sell off his holdings, this will affect other holders as the price will suffer a dip. So with market stability, large swings due to large trades will not be able to affect the market. In an illiquid market, big players or whales can severely disrupt market stability.
  3. Resistance to manipulation and swings: A more liquid asset is manipulation resistant. Due to the vastness of the crypto space, it is often difficult to keep track of the activities of other market participants like you. An illiquid crypto asset is subject to easy manipulation from a single investor or a group of investors.
  4. Quicker transactions: A crypto asset with high liquidity is bound to have more buy and sell orders completed in record time. This is because of the large number of market participants. The benefit of this cannot be underestimated especially during periods of extreme volatility. Having the opportunity to enter and exit a position in quick succession has a strong impact on the profits to be made by a trader or investor. This highly benefits short-term traders or investors who wish to make quick profits from volatility by getting in and getting out of trades fast.
  5. Accurate technical analysis: The idea of studying past statistical trends from trading activities and using the information to forecast future price movements is more useful and accurate in a liquid market. Illiquid markets are difficult to analyze since unlike liquid markets they do not usually have a big pool of information to gather data from. 

Rounding off

Now that you know what liquidity is and how it affects the health of your crypto investment, always ascertain the level of liquidity before you invest in any cryptocurrency or crypto asset. Primary is the asset liquidity. Then ascertain the exchange liquidity and market liquidity. Do not ignore red flags. In investment, being informed trumps being sentimental.

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