Investors who have mastered the definition of “what is Bitcoin” might be curious about the liquidity of the asset.
Most of the time, bitcoin may be regarded as a rather liquid asset class. On a variety of reputable, well-known exchanges, traders can purchase or sell Bitcoin. The average daily trade volume is close to $10 billion. On most exchanges, there are typically enough orders available and the spreads between buy and sell orders are typically not too wide for the average trader to avoid experiencing slippage.
Here is a quick tutorial to understanding Bitcoin liquidity.
What is liquidity
The degree of difficulty involved in turning an asset into cash—or liquidating it—without affecting its market price is what is meant by liquidity. The more readily liquid an asset can be considered to be, and the less likely it is for a market participant to affect the price by doing so.
For instance, cash is the most movable asset there is. The least liquid asset class is often thought to be real estate. There is a lot of paperwork, charges, and commissions when selling real estate, and the process can take months. Silver and other precious metals are particularly illiquid.
Bitcoin: Is it liquid or not
The liquidity of bitcoin Most of the time, Bitcoin may be viewed as being quite liquid when compared to many other asset types.
Because market conditions are always shifting, the phrase “most of the time” is crucial. It may be claimed that Bitcoin has excellent liquidity on an ordinary day. However, this may be less true in times of crisis and panic selling, or in times of euphoria and panic buying. The same is true for the majority of asset classes.
It also counts on what exchange an investor trades bitcoin. The more traders and volume there are on an exchange, the more liquid Bitcoin will be.
What Affects Bitcoin Liquidity
These are a few of the most significant factors that can influence the liquidity of Bitcoin.
Simply said, volume refers to the amount of an asset that is exchanged within a specific timeframe (e.g., daily volume). We’ll go into more depth on how volume tends to boost liquidity and reduce volatility in a moment.
Cryptocurrency exchanges operate in large part due to liquidity. There are more markets for people to buy and sell bitcoin the more reliable exchanges there are. This results in more Bitcoin being traded overall, which increases liquidity. This presented a significant barrier to Bitcoin’s liquidity in the early days of cryptocurrency.
How people store their digital assets is an intriguing factor that influences the liquidity of Bitcoin. This is a characteristic that only applies to cryptocurrencies and is largely irrelevant in the majority of other financial marketplaces.
Bitcoin is a kind of rare digital commodity, thus how it is stored matters.
People who hold significant amounts of Bitcoin are frequently proponents of “cold storage,” which entails keeping a cryptocurrency wallet’s private keys offline. Due to the fact that coins are often inaccessible to hackers and other types of thieves, this strategy is supposed to make them less vulnerable.
Of course, holding coins offline removes them from circulation and reduces liquidity.
Some academics who have investigated this idea have come to the conclusion that, as of December 2020, up to 78% of the entire Bitcoin supply was illiquid. This suggests that many Bitcoin owners are not seeking quick gains but rather intend to keep onto their investments for a while, demonstrating their belief in the utility of Bitcoin as a store of value.
Volatility and liquidity may be intimately intertwined. If one or more major traders are attempting to enter or leave significant positions, a lack of liquidity could result in an increase in volatility. If there is a limited supply of an item on the order books, prices can change quickly when traders buy into existing sell orders or sell into existing buy orders.
It requires more capital to move the market when there is a huge supply of an asset and numerous large orders. In addition, as panic selling occurs and bid/ask spreads widen, an increase in volatility can also result in a decrease in liquidity.
Higher liquidity generally results in lower overall volatility. This is one of the main causes of Bitcoin’s historical daily fluctuations of 30%, 50%, or even more. These transactions are less frequent these days as Bitcoin has a market cap over $1 trillion.