The Importance of Liquidity

Liquidity describes how easily an asset can be bought or sold in the market at a price reflecting its intrinsic value. Currency is universally considered the most liquid because it can quickly and easily be converted into other assets. Tangible assets, such as real estate, fine art, and collectibles on the other hand are relatively illiquid as there is often a lot more elasticity (variation/flexibility) in the price the transaction settles at and transactions can take quite some time to settle as it takes longer to match a buyer and seller. Other financial assets, ranging from equities to partnership units all have differing levels of liquidity.

Market Liquidity

Market liquidity refers to the extent to which an asset class, such as shares on a stock exchange or real estate in a given area, can be be bought and sold at stable, transparent prices.

Equity markets are characterized by higher market liquidity than for example a local real estate market. If an exchange has a high volume of trade that is not dominated by selling, the price a buyer offers per share (the bid) and the price the seller is willing to accept (the ask) will be fairly close to each other. Thus the larger the liquidity pool of the asset, the lower the slippage in transactions and people in the market can move in and out of the asset easily.

Investors, in more liquid assets, will not have to give up unrealized gains for a quick sale. When the spread between the bid and ask price grows, the market becomes more illiquid. Markets for real estate are usually far less liquid than stock markets. The liquidity of markets for other assets, such as derivatives, contracts, currencies, or commodities, often depends on their size, and how many exchanges exist for them to be traded on.

Liquidity and Size

Low liquidity markets present more risk to investors as slippage (the widening gap between bids and asks) can cause the settled price for large transactions to vary substantially. This is why larger investors performing larger transactions, or what traders call large size are usually only conducted in more liquid markets such as Equities or Bonds. The larger the liquidity pool of the asset, the more secure larger size players feel because they are able to move capital in and out of the asset with relatively small slippage compared to other markets with lower liquidity.

Why Wise is Changing the Game

Now that we understand the importance of liquidity lets have a look at why this is extremely important for an emerging asset class like crypto currencies and digital assets. When we look at the major crypto`s that get institutional interest and investment there is a common criteria; High Market Cap, High Volume and a Broad User Base. The above three things are the critical components that determine the liquidity of a market. The market cap indicates how large the pool of assets is or, the size of the total market. Volume indicates how often trades settle, or how many buyers and sellers exist in the market at a given time. The broad user base is where this gets critical for Digital Assets and why Wise could potentially be a game changer. The spread of the asset amongst market participants determines whether an entity can manipulate the price of that particular asset, termed “Market Concentration”. If a very concentrated market where a vast majority of the share of that market is controlled by very small number of market participants they can have a dramatic impact on price. However if there is a relatively large user base with little concentration no one entity or small group can have an outsized impact on the market. An example of how market concentration is very dangerous in crypto would be your typical golden parachutes, pre mined tokens for certain people, massive dev team token pools etc. These all lead to an extreme concentration of the asset in the hands of a small number of market participants. Wise ticks all three boxes. While the token may not have a market cap comparable to BTC or ETH; Wise will list its token with a massive ownerless liquidity pool placing the token in the top 300 Coins by market cap on Coingecko and in the top 6–8 on Uniswap, with a fair 50 day reservation presale on the tokens the project will generate a large user base and avoid an extreme concentration amongst the participants. The Wise token is essentially an Ethereum Bond, which uses the Time Value of Money principle to lock up Ether (ETH) at a given price per WISE, as more people buy WISE to lock up more ETH the WISE token appreciates in terms of ETH. The token uses an inflation rate of 4% to mint interest for stakers and is paid in WISE; creating a yield for the bond.

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By C. Streuli

Ex Banker, Trader and Crypto Nerd