Liquidity risks associated with cryptocurrency exchange services

What is liquidity in cryptocurrencies?


  • Liquidity generally refers to how easily a cryptocurrency can be converted into cash, and vice versa

    "In its most simple form, liquidity refers to how easy it is to convert cryptocurrency into cash quickly — and whether this can be achieved without the asset’s value suffering.
     
    Bitcoin, the world’s first and most actively traded digital asset, is often recognized as being the most liquid virtual currency. 
     
    Liquidity can also be used when weighing up which exchanges enable trades between fiat and crypto to be completed instantly and without price slippage. The levels of liquidity will often depend on how many users that particular platform has.

    Source: Coinmarketcap


    "Liquidity in cryptocurrency means the ease with which a digital currency or token can be converted to another digital asset or cash without impacting the price and vice-versa. Since liquidity is a measure of the outside demand and supply of an asset, a deep market with ample liquidity is an indication of a healthy market. Additionally, the more liquidity available in a cryptocurrency or digital asset, all things being equal, the more stable and less volatile that asset should be.

    In other words, a liquid cryptocurrency market exists when someone is prepared to buy when you are looking to see; and if you’re buying, someone is willing to sell. It means you may buy that digital asset in the quantity that you want, take profit from a trading opportunity, or in the worst case, cut your losses should the value of the asset fall below your costs, all without moving the market dramatically."

    Source: CFI, last revised 5 Oct 2022

FinReg business tip

Depending on the business model and transparency level, crypto exchanges may be prone to liquidity crunches. This is especially harmful for users if the exchange holds its customers' cryptocurrencies as a custodian, since they risk losing their assets.