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Swimming in Liquidity Pools: What You Need to Know

July 20, 2022
Features, Education

Discover how liquidity works in the DeFi market, why it's important, and how to find coins with good liquidity. Learn more about liquidty pools and locked liquidity.

Are you interested in learning more about liquidity and how it affects the cryptocurrency market?

Knowing the importance of liquidity and how to identify coins with good liquidity can help you make better decisions when investing in crypto. In this article, we'll discuss what liquidity is, why it's important, and how to find coins with good liquidity. Let's dive in!

What is Liquidity?

The term liquidity refers to how easily an asset can be bought or sold on the market for cash or other coins. It’s also a good way how to measure the health of the coin.

In DeFi, liquidity is stored in so-called Liquidity Pools which anybody can create or participate in. Users (liquidity providers) add an equal value of two tokens in a pool to create a market. As a reward for providing their funds, they get a share from trading fees.

Importance of Liquidity

Liquidity is especially important when it comes to cashing out the assets. Imagine that you have the rarest Pokémon card on the planet — if there is nobody who’d want to buy it from you, you can’t convert it into cash. It means that there is low liquidity in the market.

Another reason why liquidity is important is the direct effect on volatility. Low liquidity levels are causing a more volatile market with spikes in the price. When somebody sells a big portion of the coin, it can cause the price to drop by tens of percent.

If you’re buying a coin with low liquidity via DeFi site, you might be forced to set a high slippage (10–15%) due to price fluctuation. It simply means that there aren’t enough opposite orders at the same price level and your trade might be executed at a quite different price than intended.

Check Total Con's Liquidity

We got your back in this one. On CoinBrain, it’s extremely easy to check the coin’s liquidity on DEXs. You’ll find it on the overview of all coins on the homepage and also on each coin’s profile in the sidebar. On top of that, you can also see how is the liquidity distributed among the liquidity pools.

Good coins have usually created a liquidity pool in a pair with some of the major tokens or stable coins (BNB, USDT, USDC, BUSD,…) and their liquidity is locked for a long period of time (at least 1 year).

Locked Liquidity

Locked liquidity” means that the liquidity pool creator can’t easily remove the liquidity and run away with the money (so-called rug pull).

For smaller cap coins, we really recommend to pay attention to the liquidity structure: how much of it is locked and for how long. One of common tricks is to lock liquidity only for hours or to lock just a very small portion of it.

The Higher Liquidity the Better

As we already explained, the higher liquidity the better. However, it might be tricky to set an exact level where the coin can be considered well liquid. It’s mainly because of the diverse needs of various market participants.

A casual trader who’s not trading more than a few hundred dollars might be able to easily cash out even from coins with the liquidity of a few thousand dollars. On the other hand for some traders not even $1M liquidity would be enough. As a rule of thumb, we recommend the liquidity to be at least 100x bigger than your trade size.

Another angle on how to look at liquidity is through the Liquidity to Market Cap ratio. It’s basically telling you what percentage of the coins on the market can be easily converted into cash at the moment.

How to find coins with good liquidity?

CoinBrain offers the best tools for searching coins based on their liquidity. You can easily set filters for minimum and maximum liquidity amounts and sort all existing coins which meet your criteria by ascending or descending.

Conclusion

It is clear that liquidity is an important factor to consider when investing in cryptocurrencies.

Understanding how liquidity works and how to identify coins with good liquidity can help investors make informed decisions and protect their funds. By using tools such as CoinBrain, investors can easily find coins with good liquidity, allowing them to make the most of their investments.

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