The liquidity describes how quickly and at what cost an asset can be exchanged for another asset. Liquidity is a measure of how many buyers and sellers are present, how active the market is, and how big their orders are. It can be calculated by taking a volume of market trades and a volume of current pending orders on the market.
In some sense, market liquidity can be compared to popularity, meaning each market and crypto exchange has its liquidity.
Liquidity is considered “high” when there is a significant level of trading activity, a lot of market participants, and high supply and demand in the market. It helps buyers and sellers easier to find each other and provides fewer chances that one particular order may affect drastic price change. But if there are only a few market participants and trading activity is low, then such a market can be considered low-liquid or even illiquid.
Liquidity is a dynamic indicator that constantly shifts from high to low depending on trading activity and volume. When trading, market liquidity significantly impacts how quickly you can open and close positions, and how big the difference is between buying and selling prices. It means liquidity is one of the key factors in determining spread. In general, when markets become more liquid, the bid-ask spread should tighten and vice versa. But high liquidity does not always mean a balance between buyers and sellers. That is why in the case of significant imbalance, it can be more difficult to fill your order.
When you trade, it is also important to know who you are in the market in terms of liquidity — maker or taker. One of the reasons is that it can affect your fees. On CEX.IO, there is a difference between maker fee and taker fee.
Maker is the one who adds liquidity to the order book, creating a market and making it easier for others to buy or sell when order conditions match. This happens when your orders aren’t carried out immediately. For example, when users place a limit buy order below the current market price or a limit sell order above the current exchange rate they can be considered as crypto market makers.
Taker is the one who takes liquidity from the order book. And such a situation occurs when you place an order that executes instantly against another order available in the order book. So it can be said that filling orders remove part of liquidity. Note that takers are not the only ones who place market orders. If there is an opposite limit order that can match your order conditions and fill it, then your trade will be considered as a taker’s trade.
Knowing who you are in terms of liquidity and what is the current situation in the order book will help you make more well-informed trading decisions and find promising market conditions.