What is liquidity?
Generally, when we talk about financial education, we often encounter liquidity and how important it is to always keep a percentage of our investment portfolio in liquid assets. This liquidity directs to the efficiency and ease of exchanging these specific assets into money without influencing the market’s price
But, of course, the most liquid investment is money itself or emergency deposits and savings accounts — even cryptocurrencies. Other examples of liquid assets could be equities and ETFs that investors can quickly sell on the market if they need money urgently. Unlike real estate, cars, or collectibles, which can take up to several months to find a buyer, other assets are usually liquid enough.
How many liquidity types are there?
In the financial world, there are two classes of liquidity:
1. Market liquidity
2. Accounting liquidity
Market liquidity refers to the explanation used in our introduction, and it’s the most common liquidity that measures the extent to which equities, cryptocurrencies, or real estate can be purchased and traded at set and concrete prices.
The markets where investors actively trade have enormous liquidity because the price a buyer is willing to pay for a cryptocurrency is very close to the price a seller is inclined to accept in the same transaction. Thus, investors are not required to give up on unrealized profit to sell a digital asset quickly.
When the difference between offered and asked price is lower, the market has more liquidity and vice versa. Conversely, the market has less liquidity when the exact difference is more significant. The market’s liquidity for other assets, like derivatives, currencies, and commodities, often depends on their size. There are cases when specific equities or cryptocurrencies are more liquid than others, depending on people’s interests and the daily traded volume.
Accounting liquidity refers primarily to companies, and the ease with which they can fulfill their financial obligations with available liquid assets — or, more professionally said, their ability to pay debts in terms. In investing terms, evaluating accounting liquidity means comparing liquid assets with financial obligations, depending on their maturity.
Why is liquidity significant?
Liquidity is essential when talking about financial education and markets we’re trading, whether they’re crypto or equities. For example, let’s imagine that tomorrow an emergency appears in someone’s life, and a sum of money is required for an urgent operation that can not be done until the money is sent (supposing that the person travels without international medical insurance).
Also, we can own diverse objects that used to have value at some point — old coins, archeological treasures, or rare bottles and trinkets, evaluated at hundreds or thousands of dollars. However, if there are no interested buyers, then the estimated value for these objects is not relevant.
Moreover, if companies do not make sure they own enough valuable assets that are highly liquid, and if they cannot fulfill their payment obligations, this situation will create a liquidity crisis that can lead to bankruptcy.
Are crypto “liquidity pools” related to the term?
Not really. Those liquidity pools are virtual places where users can deposit assets to form several trading pairs, which will be liquid for other users that want to trade the same pairs. Liquidity pools work based on Smart Contracts, through which trades are automatically executed between the buyer and the seller. Thus, in this case, we talk about how traders imply their assets in the market to provide liquidity for other investors.
Did you find this information useful? The more you learn about crypto, the more ready you are to start your own trading journey. Register on IXFI to enjoy the benefits of a modern and advanced trading platform. Your Friendly Crypto Exchange has you covered, from high security to advanced trading features and an intuitive design.
Disclaimer: The content of this article is not investment advice and does not constitute an offer or solicitation to offer or recommendation of any investment product. It is for general purposes only and does not take into account your individual needs, investment objectives and specific financial and fiscal circumstances.
Although the material contained in this article was prepared based on information from public and private sources that IXFI believes to be reliable, no representation, warranty or undertaking, stated or implied, is given as to the accuracy of the information contained herein, and IXFI expressly disclaims any liability for the accuracy and completeness of the information contained in this article.
Investment involves risk; any ideas or strategies discussed herein should therefore not be undertaken by any individual without prior consultation with a financial professional for the purpose of assessing whether the ideas or strategies that are discussed are suitable to you based on your own personal financial and fiscal objectives, needs and risk tolerance. IXFI expressly disclaims any liability or loss incurred by any person who acts on the information, ideas or strategies discussed herein.
