Several factors determine a company’s or asset’s sustainability in the investment context, one of which is liquidity.
As a result, liquidity certainly plays an important role in carrying out efficient financial transactions.
This is because liquidity is a matter of great concern to investors or shareholders, particularly about asset resilience and evaluating company performance.
Therefore, liquidity also plays an important role in crypto investment as an investment instrument.
So, to better understand the meaning, types, and how to calculate liquidity, including crypto assets, see the following review.
What is Liquidity?
The definition of liquidity is a measure that shows how much a company’s ability to meet current obligations in a short time.
A company is called liquid when it has current assets as a means of payment higher than all of its obligations.
So, if a company’s liquidity level is high, the company’s performance will be seen as getting better and vice versa.
Therefore, liquidity becomes crucial in the financial context because it determines the company’s sustainability.
On the other hand, liquidity is also assessed as the ability of an asset/financial instrument to be sold, bought, or exchanged quickly without disturbing the price.
In this case, the faster an asset can be sold, bought, or exchanged means that the asset has good liquidity.
Referring to the definition, liquidity has different types from one another.
Liquidity can be classified into several types, from assets and markets to accounting.
So, here are the types of liquidity you need to know and their descriptions, including:
1. Liquidity of assets
Asset liquidity is a measure that shows the ease with which an asset can be converted into cash or sold.
Each asset has a different level of liquidity.
2. Market liquidity
The second type is market liquidity. In this type, liquidity is defined as market conditions when an asset can be traded.
A liquid market will allow buying and selling of assets in large quantities and vice versa.
3. Accounting liquidity
Last, on this list, there are types of accounting liquidity. This liquidity refers to the company’s ability to pay short-term debt in a short time.
Thus, if the company has good liquidity, it can fulfill these obligations.
Liquidity functions as a measure of a company to attract investors.
The reason is high liquidity, and the company will signal that its finances are healthy.
In addition, the company will also be seen as pocketing a minimal risk of loss.
The following are other functions of liquidity that need to be known, including:
- If one day, the company has a sudden need. Liquidity can be an anticipatory fund.
- To meet short-term debt, liquidity can measure the availability of cash and cash equivalents.
- Companies can use liquidity to carry out business activities every day.
- To assist company management in supervising the efficiency of the company’s capital.
- Liquidity can be a helpful tool for conducting financial analysis and interpreting a company’s financial position in the short term.
Liquidity in Crypto Markets
In crypto investment, the notion of liquidity is a measure/indicator that describes the condition of a crypto asset, starting from price and volume to total orders.
A simple example can be seen when investors/traders want to quickly convert crypto assets or convert them into cash (fiat currency).
Later, price differences that are not too far apart and do not result in significant losses can show the liquidity of these assets.
Liquidity has a close relationship with trading and price stability of cryptocurrencies.
The reason is, in the crypto industry, the trading level of buying and selling crypto assets will also be affected by the liquidity of crypto assets.
In addition, the level of liquidity also significantly affects the stability of crypto prices.
That is, crypto investors/traders will use liquidity as an indicator to review an asset’s feasibility, price, and stability.
Meanwhile, the size of liquidity in crypto, at least, is determined by three indicators, including daily trading volume, participants, and the bid-ask spread.
The daily trading volume refers to the total amount of crypto assets exchanged on the crypto exchange platform in a period.
Another measure is participants, which refers to the participants in the asset, both sellers and the buyer.
On the other hand, the bid-ask spread is the difference between the highest selling price (bid) and the lowest buying price (ask) in the order book.
In this case, if the spread is narrower, then a crypto asset will be said to be more liquid.
Why is Liquidity So Important for Crypto Investors?
For crypto investors, liquidity is very important because of the following reasons, including:
1. Allows investors to enter and leave the market easily
Investors can easily determine when to enter and exit the market by paying attention to crypto liquidity.
In this case, liquidity will underlie market conditions and situations that investors can analyze.
2. Ensuring the liquidity of assets owned and the ability to earn profits
Liquidity is also a tool/measurement used to conclude the feasibility of purchasing a crypto asset.
3. Minimize the risk of significant price reductions
Liquidity is one of the important factors investors consider to choose more stable assets to prevent the risk of a drastic drop in prices.
Factors Affecting Crypto Liquidity
Many factors affect crypto liquidity which will be taken into consideration by investors/traders.
As mentioned earlier, liquidity will be a consideration for crypto investors/traders to buy an asset.
Typically, several factors affect crypto liquidity, including the following:
1. Exchange Platforms
The exchange platform (crypto exchange) will usually affect the liquidity of crypto assets.
A crypto asset will be listed on many exchange platforms when its popularity skyrockets.
Of course, this will increase the exposure of these assets and attract the interest of many investors/traders.
2. Asset Popularity
One of the things that also affects the liquidity of crypto assets is popularity.
In this case, the popularity and large community of crypto assets will make the liquidity of a crypto asset even higher.
3. Market Makers
Both traders and investors are known to be passionate about making market volumes.
On the other hand, market makers are often encountered these days but are often misunderstood.
Market makers are not entirely market manipulation activities but have an important role in building a stable crypto asset market when you first enter an exchange platform.
How to Account for Liquidity in Crypto Investments
For crypto investors, of course, it is important to consider the liquidity in crypto investments that will be made.
This calculation is important for investors to avoid significant losses and achieve maximum profit.
Here are some ways that crypto investors can do to calculate liquidity in crypto investments, namely:
1. Choose assets with high liquidity to facilitate transactions
First, investors can choose assets with high liquidity to facilitate future transactions.
Please note assets with high liquidity will be easier to transact, for example, withdrawals and others.
2. Observe trading volumes and bid-ask spreads before investing
Before investing, it is also important for investors to observe trading volumes and bid-ask spreads.
By paying attention to these two things, investors can make the right analysis before investing in crypto assets.
3. Use an exchange platform that has good liquidity
Finally, on this list, the way that crypto investors can calculate liquidity in crypto investments is to use an exchange platform that has good liquidity.
This is because an exchange platform with good liquidity will help investors to be more calm in investing. After all, it guarantees its sustainability.
In conclusion, liquidity plays an important role in crypto investing.
This is because liquidity is one of the things that investors in the crypto industry pay close attention to as a basis for making investment decisions.
In this regard, liquidity plays a role in determining the feasibility and sustainability of an asset to be owned/purchased by investors.
Furthermore, it is also important for investors to understand the types of liquidity and consider them in making investment decisions.
The reason is that with proper understanding and analysis related to liquidity, investors can avoid the risk of significant losses and make profits.
Now, you know what liquidity is, including in the crypto market, and how to calculate it.
Next, for those who want to learn crypto investment, you can learn it at INDODAX Academy.