The concept of liquidity has many facets to it. One way of defining liquidity is the ability of an asset to be converted into cash readily on demand. Another way of looking at it is when any asset can be bought or sold at its fair price. Liquidity thus means that there aren’t discounts or premiums attached to it during buy or sell and it’s easy to enter and exit the asset. It is believed as more of an item is bought and sold, the chances of charging premiums or giving discounts lower and such an asset usually trades around ‘what it is worth’. The forex market is often defined as a liquid market with an average turnover of more than $5 trillion daily according to the Bank for International Settlements (BIS) while real estate is a classic example of an illiquid asset. Property as an asset is less liquid, requiring huge investments into physical form, tedious procedures and smaller market.
Liquidity is important for any tradable asset, which includes the math based currency Bitcoins as well. Liquid markets are deeper and smoother while illiquid market can put traders in a spot from where it’s hard to navigate the way out. Bitcoins have seen a significant grown in the last five years of its existence from 50 Bitcoins in 2009; the circulation is more than 13,000,000 today. The graph above depicts the growth of Bitcoins in terms of circulation. However, the virtual currency has witnessed episodes of illiquidity. Let’s take a look at the main factors which influence the liquidity of the Bitcoins.
The increase in the number of trusted Bitcoin exchanges will provide opportunity to more people to trade their coins. The increase in frequency and volume of trading helps to enhance liquidity. There are people who are holding their Bitcoins, more opportunity in terms of secure exchanges can make many to trade their Bitcoins and add more buyers and sellers to the market place. (See: A Look At The Most Popular Bitcoin Exchanges)
The increased acceptance of Bitcoins at brick and mortar stores, online shops, bookings, etc can help to increase its usability along with reducing its volatility as more will come into circulation. The more it is used as a medium of payment, the more liquid they become. There is already a growing trend in its usability at various stores, both online and offline. The increasing use will help to also realize a fair price for this asset. (See: Stores Where You Can Buy Things With Bitcoins)
- ATMs & Payment Cards
The network of Bitcoin ATMs is fast increasing; recent ones (as of November 2014) have opened in Virginia, Pennsylvania, Oregon, and Massachusetts. The Bitcoin ATM’s are of great importance for the wider acceptance (both cause and effect) as they also facilitate buying of Bitcoins. There are many people who are not comfortable with an online exchange transaction; these ATMs are a great resource in such cases. However, this mode of making purchases is much more costly than online exchanges. In addition to ATMs, debit cards and credit cards have also started to hit the Bitcoin world, making it easier to carry out transactions and purchases. The launch of Bitcoin-to-cash payment cards and ATMs are a step forward in increasing the usability and acceptance of Bitcoins. These will facilitate purchase and withdrawals at the market price of Bitcoins and help to increase liquidity while maintaining security. (See: Ways To Earn Bitcoins)
Regulations directly and indirectly have a very crucial role to play. The stance of countries on Bitcoins is as different as the countries themselves – it is banned in a few, allowed in some and in dispute everywhere else. Authorities in many countries are observing the situation and many are even working on the regulations. Despite the ambiguity on this front, the virtual currency is growing at a fast pace. There is an increasing presence of Bitcoins in the form of ATMs, exchanges, transactions in shops, casinos and so on; clear stand by authorities on issues like consumer protection and taxation could bring out more people in the open to use and trade Bitcoins, which will affect its liquidity. (See: Bitcoin IRS Tax Guide For Individual Filers)
Many people may have heard the word “Bitcoins” but are practically unaware of what a virtual currency is or how it works. Among these people can be many prospective buyers, investors, traders of these digital coins. Limited knowledge and lack of clear guidelines by authorities has limited it to enthusiasts till now. As the Bitcoin world is expanding, its popularity and acceptance is growing alongside, which will bring in many more to try it out. (See: How Bitcoin Works)
The Bottom Line
If we look at Bitcoin as an asset, it certainly has given lucrative returns. Bitcoin has its issues, volatility in price being one of them. The liquidity problem is one of many factors which lead to the sudden movement in the Bitcoin prices, and thus an improved liquidity can help combat the same. The way forward for this currency is hard to predict but its foothold is increasing with time. (See: The Risks Of Buying Bitcoin)