Not being an experienced trader, I have been trying to better understand some of the basic trading/market concepts that could impact my portfolio. I’m not talking about day trading and charting, but more fundamental concepts around the volatility of cryptoasets and what may happen if I need to sell fast. There's one idea that has stood out most and caused me to question the true value of my portfolio...
Asset Liquidity
Liquidity is the term used to define how easily and quickly an asset can be sold. Assets that are more liquid can be sold/spent easier than assets that are illiquid. So Apple stock are more liquid than your house. Cash is the most liquid of all.
One of the big factors for making an asset liquid is the demand for purchasing an asset. This has very big implications to the value of your portfolio. You may look at your Blockfolio app and see that your portfolio is up 10x what you put in. Amazing! But not so fast. What if you actually wanted to sell all of your assets today? How liquid would the be?
Using order book to determine liquidity
To get an idea of how liquid a cryptocurrency is you can look at the order book on the exchange. You’ll see a list of buy orders and sell orders. The sell orders show how many units of an asset are up for sale at a given price. The buy orders show how many units can be bought.
Now let’s say you have 10,000 units of coin ABC worth .001 BTC each (10 BTC total) that your bought for .0000001 BTC (1 BTC total). While you may think you’re up 10x, your gains may be far less if there is not enough liquidity. Let’s say the order book looks like this:
- Buy order for 2,000 at .001 BTC (2 BTC total)
- Buy order for 5,000 at .0008 BTC (4 BTC)
- Buy order for 3,000 at .0005 BTC (1.5 BTC)
If you create a market sell order you would sell all 10,000 of coin ABC for 7.5 BTC instead of 10 BTC since you would sell coins in order of the highest buy orders on the order book. If you wanted 10 BTC you would need to set a limit order to sell all 10,000 units at .001 BTC and then wait until matching buy orders are placed. If the market is dropping or the asset/exchange has very low volume, then those buy orders may never come and your portfolio may be worth A LOT less than you thought.
What this means
Be careful trading on low volume exchanges or low market cap coins with very little daily trade volume. Also keep this idea in mind if you are unloading a very large stack of many altcoins. You may also want to play it safe and take profits along the way on shitcoins while there is liquidity to avoid getting completely rekt in a market collapse.
Hope that helps others like it helped me!
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