Bitcoin has already become digital gold. Users around the world make fast, secure and cheap transactions without centralized interference, and traders make money on this asset. However, making profits in the cryptocurrency market depends on understanding the mechanisms of price formation. At first glance, simple concepts such as Ask, Bid, and Spread play an important role in trading strategies as well as in trend and risk assessment. In this article, we will discuss the importance of calculating asset liquidity and how to measure Bitcoin’s liquidity and what volatility has to do with it.
Liquidity as a key parameter of Bitcoin
To understand if an asset is liquid, it is worth analyzing how easy it is to exchange it for fiat money and trade it without affecting its exchange rate. Liquidity has two main characteristics: ease of exchange and price impact (slippage or difference between expected and actual price in a large order). If the asset is liquid, the trader can make transactions quickly and with minimal losses.
Liquidity plays an important role for financial markets, because the more liquid the market is, the more stable it is. When buying or selling Bitcoin, there will always be traders who are willing to execute an order with minimal impact on the price of the asset. The price of a less liquid altcoin, on the other hand, is likely to change significantly as a result of a large transaction.
To execute a large trade, you will likely have to “tear down” several levels in the order book, ultimately increasing the bid-ask spread as well as raising or lowering the price of the asset. In this scenario, not only will the trader get price slippage, but the volatility of the asset itself will also increase. Thus, other things being equal, the price of a more liquid asset will behave more stably.
Interestingly, Bitcoin turned out to be one of the most stable assets during the global financial crisis, which was observed in the spring of this year. At the same time, previously Bitcoin’s rate did not correlate with other assets, but in recent months it has shown a strong correlation with stocks and other traditional assets.
JPMorgan analysts say that during the difficult situation in the world, the cryptocurrency environment has shown itself to be quite stable, with liquidity on major cryptocurrency exchanges preserved, unlike traditional markets.
Of course, bitcoin’s liquidity sagged during the market’s peak fall, but recovered much faster than liquidity in traditional markets. According to experts, bitcoin’s market depth is already above the average for the year, while liquidity in more traditional asset classes has yet to recover.
Thus, we can congratulate us, crypto-friends – we have passed the stress test!
Is Bitcoin a fickle asset?
The price of the main cryptocurrency is constantly changing, which leads many to believe that this is what volatility is all about. But in fact, it works differently.
I would like to point out that volatility is everywhere: financial markets, the political arena and even your relationships with your neighbors. In fact, any sudden changes and unpredictable events can be considered as volatility. But often these changes have negative consequences.
Volatility is the antonym of stability. It deters and attracts at the same time. Investors do not like volatility until a sharp jump in the value of an asset makes them several times richer, and traders enjoy it, but until the moment when they have to pay too high a price for risks.
However, there is a misconception that low liquidity leads to high volatility. On the one hand, it makes sense, but it is not accurate. Studies have proven that high volatility actually leads to low liquidity, not the other way around. Market participants try to compensate risks from fluctuations by keeping unstable assets (not selling assets under any conditions in hope that the situation will level off and the rate will go up).
Bitcoin is considered a high-risk asset precisely because of its high volatility. But bitcoin is a unique asset and in order to better understand the cryptocurrency market, you need to understand the following few points.
In fact, only the number of one-time jumps has decreased. But what is this about? It’s about the fundamental value of bitcoin.
Bitcoin’s true value
Bitcoin can be considered a real asset because it does not depend on the price of others. It cannot be called a stock or a bond, but it is possible to draw parallels with real estate or even natural resources. Also, it is impossible to estimate the cash flow from bitcoin. Therefore, it is very difficult to determine its real value.
So what then influences the determination of Bitcoin’s price? You and I and our mood. The price of Bitcoin will be what we are willing to pay for it.
This is why Bitcoin is called digital gold, because gold does not create cash flow and its price is determined by the sentiment of market players. This precious metal saw its value skyrocket in 1980, tripling in value.
However, bitcoin’s volatility is still much higher. But why does this happen? Of course, the technology can still be called new, even though it was launched 12 years ago.
At the same time, hundreds of articles are written about Bitcoin every day and it affects the mood of the market. And sentiment is a determining factor in the value of Bitcoin. But you have to understand that the price of Bitcoin will remain volatile until its ultimate potential and scope become clear. That won’t happen today and is unlikely to happen tomorrow, so bitcoin volatility will remain high even if millions more new players enter the market and liquidity grows tenfold.
What will happen to volatility?
Will Bitcoin always be volatile? No, it will be until the uncertainty barrier is broken. When we answer the questions posed above, the coin will become stable, its fair price can be calculated much more easily.
Until then, the price will continue to depend on market sentiment alone.
However, this is not a bad thing and high volatility can be your assistant in trading.
It’s no secret that as the crypto industry evolves, more research and new tools are emerging to analyze cryptocurrency sentiment and make better predictions, allowing investors to earn more and minimize risk.
On the other hand, high volatility is closely tied to huge returns. If it wasn’t, the world wouldn’t know about bitcoin millionaires, no one would make x2 or x10, and no one would earn daily even on flotsam.