Liquidity is a crucial factor in the crypto market. Among various parameters, it is the one that can most significantly influence prices, aside from major systemic events.
The function of liquidity in the financial system
The assets that can be swiftly and easily traded on the market are referred to be "liquidità."
As money was designed to be quickly exchanged in a very short amount of time, it is the most liquid instrument of all.
Some assets, including those that are locked until a specific date, are also very difficult to sell.
There are various levels of liquidity since an asset is deemed more liquid the more quickly and easily it may be sold.
Money is the most liquid asset available, while physical gold is slightly less so. Real estate, by its nature, is not very liquid because selling it takes time, and some assets can be entirely illiquid if they cannot be spent, such as seized funds.
Generally, assets traded on financial markets are liquid, except those that are restricted and cannot be transferred. However, even within financial markets, there are varying degrees of liquidity.
Specifically, when discussing true liquidity in financial markets, we refer to money and assets that are essentially highly liquid forms of money. In other words, liquidity in financial markets consists of the most liquid assets, such as cash in both physical and digital forms, and very short-term investments that are considered equivalent to cash.
The crypto market is just a segment of the broader financial market. Therefore, what holds true for traditional financial markets also applies to crypto markets concerning liquidity.
However, what differs are the assets considered liquid in the crypto market. Similar to traditional financial markets, fiat money plays a significant role in providing liquidity in the crypto market.
However, contrary to common belief, fiat money in crypto markets isn't the most easily and quickly transferable. For instance, withdrawing or depositing fiat currency on exchanges can take from a few minutes to several days, whereas movement with other assets is often easier and faster.
Hence, in the crypto market, the majority of liquidity is comprised of tokens that mimic fiat currencies, known as stablecoins.
The flow of liquidity
When it comes to liquidity on the financial markets, the velocity of trading is more significant than the volume.
A million dollars traded more than ten times a day would have a greater influence than a billion dollars traded only once a day.
The real causes of market volatility are the abrupt shifts in liquidity from one item to another.
Generally speaking, however, the total fluctuation in liquidity is very important when it comes to long-term price movements. For instance, the Fed's injection of more dollars into the financial markets in less than two years between 2020 and 2021 than there were in total in 2019 resulted in a general strong and abrupt surge in all prices.
Put simply, an increase in liquidity typically leads to inflation as it stimulates higher purchasing demand. Consequently, changes in overall liquidity are crucial in the medium to long term, whereas the speed of liquidity movement is more significant in the short term.
For instance, cash sitting idle in a bank account has minimal impact on financial market volatility, but when used to buy financial assets, it can drive up prices.
The state of the cryptocurrency market and liquidity right now
An indicator helpful in gauging the current liquidity level of the crypto markets is the trading volumes of stablecoins. Notably, USDT consistently records the highest trading volumes in the cryptocurrency realm, indicating its high liquidity.
Generally, the daily trading volumes of USDT in crypto markets, around $100 billion, are approximately double those of Bitcoin and Ethereum (both around $50 billion) and about 10 times higher than the second-largest stablecoin, USDC ($10 billion).
In contrast, the overall trading volume of USD in traditional financial markets far surpasses that of stablecoins in crypto markets. For instance, individual stocks like Nvidia often exhibit daily trading volumes not significantly different from those of USDT in crypto markets, and nearly double those of Bitcoin or Ethereum.
Considering the overall trading volumes across all cryptocurrencies, the crypto market has recently seen daily trading volumes exceeding $100 billion, compared to around $70 billion at the beginning of May. However, during the peak in mid-March, they reached $150 billion, still below the all-time highs of $300 billion traded on April 19, 2021.
These fluctuations in liquidity within crypto markets vary not only from day to day but also from period to period, with significant spikes during bull runs and substantial contractions during bear markets. It's worth noting that these variations not only impact volatility but also influence prices, with lower liquidity tending to correspond with lower prices, and vice versa when liquidity increases.
May 2024, Cryptoniteuae