The concept of liquidity in DeFi refers to how quickly and easily one can sell or purchase a particular cryptocurrency without it having a significant impact on the price of that asset. It’s typically used as a gauge to assess the market’s efficiency and the availability of participants willing to engage in transactions.
A liquid market allows investors to realise gains when a price rises. Equally, a liquid market enables investors to minimise their losses, as it enables them to sell quickly and efficiently when a token price is in decline. The concept applies not just to transactions where an investor wishes to convert crypto tokens into fiat, but also when people wish to exchange one token with another.
A liquid market is generally desirable as it is conducive to efficient transactions and indicative of stable and efficient market conditions. Liquidity is a crucial concept in economics. When there is a lack of liquidity, even relatively small transactions can easily move the market and impact prices. This creates a risk of market manipulation by people seeking to profit from sudden changes in the price of a given token. Crypto markets have generally suffered from liquidity issues during this most recent bear market.