February 4, 2023

This post was originally published on Zelcore

FTX, one of the world’s largest centralized crypto exchanges, has filed for bankruptcy after failing to meet its crypto liquidity obligations (among other shady dealings and abuse of an unregulated, centralized financial system).

In the wake of a CoinDesk story that indicated that most of FTX’s liquidity was held in its native token, FTT, investors rushed to pull their money from FTX. The result was billions of dollars in liquidity obligations that FTX could not service.

Although there’s more to the story, one of the big lessons we get from the FTX saga is that actual crypto liquidity is critical to De-Fi (decentralized finance) transactions.

As a crypto investor, it is helpful to understand crypto liquidity and what it means for your investments.

Crypto Liquidity and Zelcore

Liquidity in crypto converts one crypto asset to another crypto asset or cash without significantly affecting the original asset’s value.

An example of liquidity is when you exchange US dollars for an asset. Since the US dollar is accepted widely, making it highly liquid, the transaction does not affect the value of the original asset (the US dollar).

When applied to the crypto trading market, liquidity is the ability of a crypto exchange to rely on liquidity pools to fulfill all buy and sell orders without delaying any trades or significantly affecting the price of the traded assets.

Understanding what liquidity is is one thing, but why does it matter? In the cryptosphere, liquidity is everything.

In a traditional market, a seller must wait for a buyer to come and buy an item at the advertised price. The same would happen to a buyer, who would have to wait until a seller comes with the correct item at the right price.

If this happened in the crypto market, trade would effectively halt. Crypto liquidity bridges this gap. A third party, a liquidity provider, partners with the exchange to ensure all buy and sell transactions execute in real time.

So, when you buy and sell crypto assets on a crypto exchange, you are not engaging with other traders. Instead, the liquidity provider/market maker fulfills those orders and ensures the market remains liquid and trade continues uninterrupted.

When a market has low liquidity, traders cannot easily and quickly fulfill orders, forcing the price up or down quickly, leading to volatility and unpredictability.

When a market has high liquidity, every buy and sell order can be fulfilled in real-time, making the market more stable and reducing price volatility.

In such a market, it is easier to trade with confidence because you know the market will remain stable, and you can buy or sell at any time without any limitations.

Low liquidity markets are often prone to price manipulation and gouging. For example, if you wanted to buy a vintage car, you would need to pay whatever exorbitant price the owner asks because the market has extremely low liquidity.

In crypto, low liquidity would lead to the same scenario, where buyers and sellers ask for unfounded prices. High liquidity makes it easy to change one asset to another across a wide range of trades, making it harder to manipulate the price and offering more resilient pricing.

A spread is the difference between an asset’s buy and sell price. The spread can be significant in low-liquidity markets because there are few buyers and sellers at comparable price points.

On the other hand, high liquidity markets provide ready buy and sell offers at comparative prices, reducing the need to have large spreads to compensate for the lack of buying and selling volumes.

In such markets, the more liquidity available, the lower the spreads you would encounter, making it easier to profit on smaller market movements.

High liquidity leads to stable markets, which, in turn, leads to a more robust market that can absorb market shocks. In the FTX saga, its native token, FTT, saw significant price erosion because of low liquidity.

On the other hand, Bitcoin, which enjoys high liquidity, can better absorb market shocks, with its price rising and falling but never crashing to the point where it becomes worthless.

In the aftermath of the FTX liquidity crisis, millions of FTX customers lost access to their assets after the exchange halted withdrawals. One group of customers not affected were those who opted to store their assets in a self-custody or non-custodial wallet like Zelcore.

When you store your crypto assets, including altcoins and stablecoins, on a crypto exchange, you expose yourself to the possibility of losing access to your assets if the exchange halts withdrawals.

Storing your assets in a non-custodial, decentralized wallet like Zelcore guarantees continued access to your assets behind impenetrable security that only you can access through your private keys.

Download Zelcore’s cross-platform apps today and get access to the Web3 world of apps.

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