Liquidity & Volume in Crypto: What You Must Know

Anyone who has been in the crypto market for a while can break out in sweat at the word “liquidity.” For all those who are jumping on the bandwagon, this article will help them understand the various factors that affect the crypto market on a day-to-day basis, such as volume and liquidity. These do not warrant fear, but with an understanding of these concepts, traders can navigate the crypto market like a cakewalk. Liquidity in crypto helps traders assess an asset’s value. For example, if an asset has higher liquidity, it means more traders choose to buy and sell or change the holding asset to another currency, cash, or asset without affecting the asset’s price. Similarly, crypto trading volume helps traders realize how much of the asset is bought, sold, or exchanged in a period of time. With increased trading volume, one can see an increase in market capitalization.

In this article, we will answer questions on crypto liquidity and trading volume, helping you understand the nitty-gritty of crypto trading.

What Does Liquidity Mean in Crypto?

Liquidity in cryptocurrency exchanges measures how easily and quickly one can buy, sell, or convert an asset without impacting its overall price. High liquidity ensures you have enough consumers and vendors to trade with when selling your asset at market prices. High liquidity makes it harder to exploit the market, and there is a lower risk of abrupt price swings, ensuring stability.

This allows the asset’s cost to be stable enough for you to exchange it without worrying about significantly impacting its market. High liquidity results in tighter bid-ask spreads, lowering the costs of transactions and, therefore, helping execute trades promptly. Low liquidity implies that the market is easier to manipulate, with higher risk in markets and broader price swings. Most importantly, with low liquidity comes slippage when traders try executing large orders, and it often takes more time as it becomes harder to find counterparties swiftly. As a result, transaction costs also increase with fewer buyers and sellers asking for more bid-ask spreads. 

Market Makers refer to institutions or individuals who continuously buy and sell assets on the exchange, offering liquidity by ensuring there are always orders for traders. They aid in liquidity provision liquidity of cryptocurrency by bridging the gap between buy and sell orders so trades can be made without a huge price slippage. This way, liquidity providers help make the trading environment more stable and efficient, contributing positively to crypto exchange liquidity and also profit from the difference in a bid-ask spread.

What is Trading Volume?

Crypto newbies often wonder, ‘What does volume mean in crypto?’ Trading volume measures how often a particular cryptocurrency or asset has changed hands. Investors are often known to judge a cryptocurrency’s popularity or the crypto asset’s activity in a given period through trading volume. This is why many exchanges allow investors to check trading volumes daily, monthly, yearly, and at all times to help customers make sound investment decisions. As more people are interested in a particular currency, trading volume increases along with its price. For example, after the January 2024 Bitcoin ETF launch, the trading volume of Bitcoin stood at around $1.5bn. Similarly, low trading volume in crypto usually means investors are not keen on selling or buying these assets. 

While trading volumes can work as market indicators, using trading volumes without other analytics can severely impact the investment strategy or decision. Conducting thorough crypto volume analysis is essential to understand the dynamics of buy and sell volumes.

Trading volumes often show both buy and sell volumes. Even if sell volumes are higher, the trading volume can still indicate high activity. In such a case, investors need to perform thorough research and check buy and sell volumes separately to generate profit from the trade. Further, other market indicators, such as global economic, political, and other factors, should also be considered when making a decision. 

How Liquidity and Volume Impact Your Crypto Trading Journey?

High market liquidity is often an advantage for traders as it allows them to enter and exit the market seamlessly without any significant price slippage. The ability to execute large orders without causing a substantial impact on the market price lowers the breakout risks in trades and increases the profit margin. Still, it is worth understanding that liquidity can sometimes widen bid-ask spreads. More illiquid (low liquidity) markets generally have wider spreads, making entering or exiting a trade significantly more expensive.Understanding crypto exchange liquidity is key here, as low liquidity comes with risk; when fewer trades exist, the market is susceptible to manipulation as large traders try to move prices artificially.

By executing more extensive orders, these traders generate false signals in the market, thereby roguing a fair trade.  

Volume, however, refers to the amount of trades that occur over a specific time frame. High trading volume often correlates with market sentiment, increasing the likelihood of a new price trend developing. This indicates that the asset is actively traded, typically leading to more stable and predictable price changes. On the other hand, low volume might point to a lack of confidence in the asset, which may keep prices stable or constrained. In low-volume markets, prices can move around in unexpected ways, making it difficult for traders to get a strategy right. For day traders looking to ride short-term momentum, meanwhile, high volume can be used as a signal, with low volume signaling caution.

An effective trading strategy should consider both factors, trading volumes, and market liquidity when making a sound trading decision. While high liquidity can often seem attractive for easy daily trading, it does not prevent manipulation or widespread fraud. Likewise, high volume can be a sign of solid trends, but it could lead to dangerous zones without assessing liquidity. Combining the two factors can improve a trader’s trading game and provide a good entry and exit strategy while managing risks effectively.

Understanding Crypto Liquidity and Trading Volume with an example:

Trading activity: 

The trading volume on June 13th spiked significantly above the typical daily average, reaching over 30 billion USD within a few hours. This indicates a surge in trading activity, suggesting a large number of investors were entering the market.

Increased Demand: 

The high crypto transaction volume suggests a sudden increase in demand for Bitcoin. With more buyers entering the market than sellers willing to part with their holdings at the current price, upward pressure is placed on the price.

Role of Liquidity:

In this scenario, having sufficient crypto liquidity (enough buy and sell orders at various price points) was crucial. A deep order book with many buy orders at progressively higher prices allows buyers to enter their positions without significantly impacting the price.

Role of Volume :

The high volume, along with the price increase, confirmed the bullish sentiment. A price rise without a corresponding crypto transaction volume spike could be a short-lived pump or a temporary price fluctuation. The high volume suggested more sustained buying pressure and continued uptrend.

Strategies for Identifying High Liquidity and Volume 

Book depth charts and volume indicators are tools that help traders determine whether a specific asset has enough liquidity and trading volumes. These tools are essential for developing effective trading volume strategies, as they provide insights into market dynamics.

Books Depth Chart displays order levels on the other side to give an idea of how thin or thick the market truly is. A deep order book with many buy and sell orders close to the current price represents high liquidity, allowing traders to execute large trades without slippage. 

The order book is generally divided into three columns: price, quantity, and total quantity. The first column shows the price points for the various pending orders. The second shows the number of open orders at different price levels. Lastly, the total quantity column includes all numbers between the highest bid or lowest ask prices down to the observed level. The order book only records limited orders, and market orders with triggers do not appear in the book.

Volume indicators such as the Volume-Weighted Average Price (VWAP) can be used to gauge how strong or weak a price move in an asset might be, depending on the amount traded within a specific timeframe. The trading volume around a price move often validates whether or not it has any real potential for the longer term, which should then give traders more conviction that they are on the right side of their trade. Understanding what does volume mean in crypto and using trading volume metrics can enhance this analysis.

Regarding trading, focusing on high volume and liquidity assets allows for minimal slippage (trades can be made quickly without influencing the price of that asset much) as well as low execution risks. This is especially useful for scalping, a type of trading where traders try to make money on small price changes over very short periods. In general, traders are warned to avoid low liquidity assets unless the potential rewards significantly outweigh the risks. Low liquidity can cause spreads to widen, slippage to become more severe, and prices to be much easier to manipulate in markets at one’s convenience.

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