What is liquidity?

Liquidity is how easy it is to buy or sell an asset without affecting its price.

Houses and cars, for example, are not considered liquid because their sale takes a lot of time and effort to complete.

The crypto market follows similar patterns as traditional financial markets in that an asset is considered liquid when there is significant demand for willing buyers and sellers to trade it, resulting in high trading volume. If there is low demand for it or low supply then it is difficult to trade and is considered illiquid.

Understanding slippage

Liquidity and Slippage go hand in hand. Slippage is the difference between the expected price of a trade and the actual price. It is common in financial markets and happens during periods of volatility when the price changes during the time between the trade being ordered and when it is completed.

When a trading pair is liquid, it should trade for large volume, close to the quoted market price. For example:

• Sarah wants to buy 1 unit of ABC at a price of KES.1,000;
• If the pair is liquid, her bid (buy) will be easily matched with an ask (sell) at KES.1,000;
• As there are many orders near her price point, she’s able to buy 1 ABC for KES.1,000;
• In this case, Sarah incurs 0% slippage.

Conversely, when there’s low volume and a lack of liquidity on the Order Book, slippage may be high.

• Sarah wants to buy 1 unit of ABC for KES1,000;
• Her bid (buy) will be matched with the closest ask (sell) which could be far higher than the quoted market price if the pair is not liquid
• In this example, the closest sell order is for KES. 2,000
• As a result, Sarah only receives 0.5 ABC for her KES.1,000

In the example above, Sarah has incurred 50% slippage - she has only been able to buy 0.5 ABC for the price at which she attempted to buy 1 ABC.