Liquidity is defined as having the availability of a product or market to a large sustainable audience. This is not the exact definition, but it’s relevant for this discussion. Like almost any successful product in the world, the availability of a product in multiple scenarios is crucial to its success.
In the case of my company, it’s defined by the number of network participants using our platform. The more participants, the better and wider the availability of products on the platform. I am writing this article to focus on the importance of liquidity needed for the success of the new and exciting cryptocurrency market.
So let’s start by explaining how liquidity should be created. When you bring enough buyers and sellers into one market with a high level of participation and combine it with as much price transparency as possible, the result will create better liquidity. In an exchange framework, liquidity is measured by how narrow or wide the bid-ask spreads are. The narrower the spread, the higher the liquidity.
Another VERY important factor, and certainly the most important one in the maintenance of liquidity, are the market makers. These firms commit to support the market, regardless of the conditions it falls under. Market makers are rewarded by supporting the market and usually represent the group that also helps bring any issues to the market.
Not all market makers participate in an IPO, but the more market makers that do results in better stability and less volatility expressed in an issue.
Now let’s take this same scenario and apply it to the new ICO market, which is predominantly offered on the Ethereum platform. Much has been discussed about what an ICO (Initial Coin Offering) is, so I will not bore you with those details. What I want to address is the lack of liquidity in the ICO market.
This issue will haunt the Ethereum ICO market for some time until certain conditions appear that will support a liquid market on Ethereum. Without liquidity, the ICO market is basically a pump and dump scheme.
I am not suggesting that the ICOs are all like junk/penny stocks, but I will suggest that without enough liquidity, what we will see is great participation by buyers with no support from market makers and no buyers for cryptocoins that the ICO company wants to convert into flat cash.
Liquidity begets liquidity is one of the truths of this market. When one cryptocurrency draws good demand, more players come into the market and liquidity increases. The problem with the current ICO market is that there are too many currencies.
I recently read that there are more than one thousand cryptocurrencies. That would equal about one quarter of all the stocks in the U.S. It creates a sizable amount of issues and therefore provides even more incentive to create liquidity.
But as with stocks, they’re not all liquid, and the ones that are draw more participants. This is similar to real competition; Amazon has more liquidity than Blue Apron, for example, so liquidity, especially in Amazon’s particular market, could be a considerable competitive advantage.
Let’s figure out what will make the ICO market more liquid. Regulations are the top factor. Given the Ethereum platform and its unregulated ICOs, big players would never participate. Setting up the global framework for a regulated process to issue ICOs would be a big reason for liquidity.
Regulation would also bring legitimate market makers to the ICO market, and rules will need to be created for these participants. Although it may not be very good-natured in terms of competition, the global market for ICOs needs to consolidate around a small number of exchanges.
Folks, although it represents the distributed and non-governed process, Ethereum is not conducive to the creation of a liquid market. In order to hedge the ICO exposure, a derivatives market should be created for it.
I am sure regulation, market makers and the derivative markets were not initially in the minds of Ethereum creator Vitalik Buterin. But if this market wants to have longevity, it needs liquidity.