The crypto exchange and liquidation of crypto assets are two key elements that one must be aware of while trading in these digital assets. Crypto exchanges are based on a decentralised blockchain technology that helps you to exchange, hold, as well as mine crypto assets with ease. When we talk about the crypto market, the terms “Coin Liquidation” and “Market Cap” come into the picture. So, what are these exactly? Let’s explore:
What is Liquidity Pool in Blockchain?
Blockchain technology uses cryptography to secure transactions in a decentralised finance (DeFi) ecosystem. These platforms use liquidity pools to maintain market trading flow. Liquidity pools are a patronised collective of crypto assets or tokens that are locked up in smart contracts to be used during trading on a decentralised exchange (DEX) platform.
Previously, liquidity pools were scarce due to the limited number of users across a DEX platform. To overcome this problem, Automated Market Makers (AMMs) were introduced in DEXs. AMMs facilitate automatic and permissionless transactions in the crypto market.
Significance of Liquidity Pool in Crypto Exchanges
Liquidity pools are important in an exchange, as they let traders exchange digital assets with ease and speed. When liquidity in a platform is low, it becomes very difficult to trade, and the risk of facing slippage increases. Slippage is the difference between the targeted exchange value and the executed exchange value after completing a transaction. High slippage depicts high loss value, which is truly undesirable.
Low liquidity in a blockchain exchange can lead to market volatility for particular crypto assets. This means the price offered by sellers could highly differ from what buyers would be willing to purchase. Therefore, from this we can fathom how important liquidity is for the crypto market. In case of low liquidity of a certain token or currency, liquidation of the same is done to maintain balance in the DEX.
Crypto Coin Liquidations: A Necessary Evil
In the context of liquidity, liquidation means exchanging an asset or token of less liquidity with that of a more liquid one. The most liquid asset will always be cash, i.e., it can be exchanged with almost everything. In the crypto industry, the most liquid coin is Bitcoin. When liquidity is necessary for a DEX, one might face forced liquidation to maintain market equilibrium.
Force liquidation is necessary for the DEX to maintain its liquidity pool balance, however, it is the worst fear of any crypto trader. When a trader fails to meet the market leveraged position, he has to face forced liquidation – close his business by returning his asset values in cash or stablecoins.
Crypto Liquidation prices are determined by the trader’s chosen leverage strategy, the margin of maintenance, and the buying price of the asset. Crypto Liquidations can take as long as 2 years to complete after the date of their initiation. To avoid such an instance, one should trade using a “stop-loss” strategy, where instructions are provided to the exchange to sell the asset when it reaches a particular price in the market.
What is Market Capitalisation?
The “market cap” should be a highly familiar term to a trader in any market. Crypto market capitalisation is the reference for traders to understand how big the market is for a particular asset. It basically refers to the total market value of that asset. In crypto, it means the value calculated by multiplying the market price of a crypto asset by the number of coins or tokens in circulation.
Total Market Cap depends on the real-time trading volume in a particular token or coin across the globe. One more thing that comes under market caps, is the total market supply of a coin. When a coin has more abundance, its price is relatively less than the one with a lesser number of units in a global market. So, the market cap of a coin shows its live market performance.
A coin with a large market cap is more likely to be a safe investment as compared to the ones with a small-cap or mid-cap. Large caps (value above $10 billion) show less market volatility, making the profits less aggressive; same with the losses. Traders who wish to handle greater risks to gain bigger can invest in small-cap (less than $1 billion) or mid-cap (between $1 billion to $10 billion) cryptos.
Market caps might offer some insights into the relative size of a crypto asset but do not depict how much money is flowing in the market. While market caps can highly affect the market prices, relatively smaller changes in money amounts in the market flow can largely affect the market cap of a coin. Similarly, liquidity and liquidations can also affect market prices, making them as important to consider as the market caps. Taking these factors into account is highly recommended before making important trading decisions. If you are also planning to invest or trade in cryptos, start trading on Zebpay today, India’s largest and oldest crypto exchange!