Liquidity in digital assets

Market Insights Apr 30, 2021

Liquidity can be defined as the ability to buy or sell assets in a market without causing a drastic change in their price. The liquidity profile of all tradable assets is essential to investors when they tailor their execution strategy to the reality of the marketplace.

In this memo, we discuss how to assess financial assets liquidity and explore the specificities of digital assets. We’ll then introduce a technical liquidity report from SUN ZU Lab, an independent expert in liquidity analysis for digital assets, on Trakx Top 10 DeFi index.  

How to assess Liquidity?

Liquidity is assessed by looking at both market and assets. A market is deemed liquid when there are always investors willing to trade. An asset is liquid when it can be easily converted into cash. Liquid markets are deeper and smoother, while an illiquid market can put traders in positions that are difficult to exit.

When evaluating a market for liquidity, we will start to assess the exchange, looking at its 24-hour trading volume, its order book depth (number of open buy and sell orders), and the bid-ask spread. The order book depth analysis is however subject to stop-limit orders and iceberg orders which are not always visible, meaning it might not be a fully accurate representation of all the orders and therefore the liquidity. Stop-limit orders mean that a trade is executed when the price of the asset is at or higher than a target price. Iceberg orders are large single orders broken into smaller limit orders, for the purpose of hiding the actual order quantity.

The specificities of Liquidity in Digital Assets Markets

In crypto markets, while the liquidity is also approached through the asset and market as for traditional assets, there are other specific factors to consider:

  • Number of crypto exchanges

The higher number of crypto exchanges, the more liquid is the market. There are over 200 cryptocurrency exchanges, 21 decentralised exchanges and a handful of peer-to-peer (P2P) platforms in existence today. Some are clearly dominating the market in terms of trading volume, while others are still nascent. The table below shows the biggest exchanges by daily volume. In general, a high number of cryptocurrency exchanges is beneficial to investors who can invest in cryptocurrencies through different places, which will ultimately enhance market liquidity.

Source: Messari - 28/04/21

  • Market acceptance

The success and viability of any digital asset depends on the masses’ acceptance of the blockchain and its numerous use cases. As an example, Bitcoin and other cryptocurrencies are fast gaining traction and acceptance as a mode of payment, particularly in online stores. Security and utility tokens have also the potential to bring significant benefits to both market participants and consumers. The “tokenisation” of traditional financial instruments is opening up huge opportunities for efficiency improvements across the entire trade and post-trade value chain. NFTs are currently the fastest growing blockchain use-case reshaping some sectors such as the art, entertainment and gaming industries. A higher market acceptance may contribute positively to the liquidity based on the acceptance of the tokens.

  • Regulations

Different countries’ laws and regulations are also having an impact on cryptocurrency liquidity. The stance of countries on digital assets varies; some ban them, some allow them and some dispute their acceptance. Authorities in many countries are observing the situation, while many have already started working on the regulations. A clear stand by authorities on issues like consumer protection and taxation could bring more people out into the market which would positively affect its liquidity.

Trakx Top 10 DeFi Technical Liquidity analysis by SUN ZU Lab

SUN ZU Lab, a leading independent provider of liquidity analysis for investors in crypto, has recently produced a report on the liquidity of Trakx Top 10 DeFi. The overall liquidity of the index as well as the index constituents have been analysed, through measures of capacity and slippage.

Capacity can be approached by the available liquidity according to the investor’s participation in the market, without causing adverse price movements. Slippage analysis focuses on the measure of price deterioration versus execution size.

Trakx’s Crypto-Traded Indices (“CTIs”), available on platform, are tokens which track a basket of crypto-assets and follow a number of pre-determined and transparent rules. Those rules aim at selecting the largest and most liquid assets in their category.

Top 10 DeFi gives investors an exposure to the biggest DeFi projects by market capitalisation by simply buying a single token. Investors get a broad exposure to this rapidly growing industry through a selection of varied core DeFi protocols (Dex, NFT, Lending….).

SUN ZU Lab liquidity report on Top 10 DeFi is attached here. It shows that the Top 10 DeFi index had a daily capacity of $38.4M in March, under the constraint of executing less than 20% of the daily volume on each individual index component. The deep liquidity shown in the report means that institutional investors trading the Top 10 DeFi index, at the time, were able to enter and exit positions with ease.

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Caroline Jacquard

Seasoned marketing manager with 15+ years of experience in the financial industry: traditional finance, alternative investment and digital assets. Advisor