Understanding liquidity and why a sudden $800m drop can tank a 1T market by 10%.

Good morning everyone.

Some of you might be just coming round from your daze after yesterdays market performance. We all checked our phones to find some pretty shocking news.

The thing I always found strange when I first entered this space and these sorts of events happened was that everything acted instantly, no matter which coin or which exchange. It all followed the same trend without a moments notice. I was also baffled at how much money could technically leave the eco system in such a short amount of time.

The current entire crypto market cap is very roughly 1 trillion dollars. Yesterday saw just short of 1 billion dollars in liquidation. That’s 0.1% of the entire market cap. Yet everything dropped by around 10%.

How?

Well it’s all to do with liquidity. It boils down to this. Let’s say Microstrategy woke up today and wanted to sell all of his Bitcoins. All 150,000 of them. The current price of BTC is $26,000.

He lists all 150,000 for $25,999 on Binance for sale. Immediately he will sell as many coins to as many buyers that have a bid in for $25,999 or more. After that, the sale will pause until buyers come in with that price. It would be a very tiny portion of his coins sold. Probably less than 50.

So he decides to list the remainder for $24,000. And again, orders are filled but not that many in comparison to the amount he holds. BTCs price has now dropped to below $24,000 because there’s no buyers or liquidity at $26,000 anymore. BTC just dropped 10% and microstrategy still has 140,000 BTC.

In reality, the price or market cap of a coin rests solely on its liquidity properties. If there’s only enough money on the table for 1 BTC at $26,000 then it’s going to be a rough ride when someone sells.

Below are some points I’ve made regarding liquidity and what you should understand.

• Liquidity is the measure of how easily an asset can be bought or sold without causing significant price changes. In the cryptocurrency context, it reflects the ability to convert a digital asset into cash or another asset promptly. Liquidity depends on the presence of active buyers and sellers, as well as the depth of the order book.

• Liquidity acts as a measure of market stability. High liquidity implies a balanced number of buyers and sellers, resulting in smoother trade execution and less impact on prices. On the flip side, low liquidity scenarios lead to heightened price volatility. A large trade in a low-liquidity market can result in exaggerated price fluctuations.

• Market volatility, which often puzzles traders, can be attributed to liquidity dynamics. In markets with low liquidity, even small trades can cause significant price shifts. This results in the price volatility that characterizes cryptocurrency markets.

• In markets with high liquidity, large trades can be executed with minimal price impact. Bid-ask spreads remain narrow, ensuring fair pricing for traders. High liquidity also makes it harder to manipulate prices, contributing to a more accurate representation of asset values.

• Low liquidity markets are prone to price manipulation due to the influence of large holders. Executing significant trades in such scenarios can lead to slippage, where the executed price differs from the expected price due to insufficient orders to match against.

In summary, grasping liquidity is crucial for navigating the cryptocurrency landscape. It directly affects stability, volatility, and the trading experience. While high liquidity promotes stability, low liquidity demands caution due to potential price swings and manipulation risks.

It’s a lot to take in and bend your head around but it is the fundamental force of all crypto markets, even BTC with its massive market capitalisation is subject to its underlying importance.

I hope this helps, if you have any other topics you’d like me to cover please let me know! ????

EDIT: Wow thanks for the upvotes guys. Glad I could be of some help. Remember if you have any suggestions for more topics I’ll certainly do my best. Have a great day everyone!

EDIT 2: 1000 upvotes? You guys are awesome. Thanks again, happy Sunday!