Liquidity
Written by Ryan Watkins
Introduction
Liquidity is the degree to which an asset can be sold without causing a change in the asset’s price. In other words liquidity is not just about whether or not you can buy or sell an asset since anything can be bought or sold quickly for a price, but whether or not you can buy or sell it equal to or close to its last price. Liquidity is a product of both the depth of buyers and sellers in a market (which allows a market to absorb larger buy and sell orders without significantly moving the price) and their willingness to buy or sell. Cash is the most liquid asset in the world due to its ability to be sold for goods and services instantly with no loss of value. Cash can be used immediately to perform nearly any economic action such as buying, selling, or paying debt.
However, it is important to note that no asset is liquid or illiquid by its nature. Liquidity depends among many things on market conditions, volume, and whether or not you are attempting to buy or sell given those conditions and the size of your order. For example, if a market is in panic mode and everyone is attempting to sell an asset, if you are also attempting to sell that asset you may find that doing so is difficult, requiring either a significant discount to its last sale price or an extended amount of time for a counterparty to take the other side of the trade to buy your asset. Likewise for an asset that is very thinly traded, an attempt to make a trade with size may move the price of the asset substantially. For example, if an asset trades 100,000 units a day and you want to purchase 1,000,000 units it would likely take many days to accumulate the 100,000 units you want and/or require a significant premium to convince the limited amount of sellers in that market to sell their units to you
Suggested Reading
Oaktree Capital - Liquidity by Howard Marks
Bitcoin Liquidity: How It Can Hurt You, and How It Can Help You by SFOX
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