It’s no secret that Bitcoin’s first mover advantage has led to large network effects. But what are the real advantages of those effects? In the past, we’ve covered Bitcoin’s relatively low levels of price volatility as one advantage, but liquidity and slippage are two other factors that deserve attention.
Liquidity is effectively a measurement of the ease at which someone is able to quickly obtain or sell an asset without causing large changes in that particular asset’s price. If an asset can be sold in a timely manner or exchanged for goods or services without having much of an effect on the market price, then that would be considered a liquid asset. Traditional fiat currency (in cash form) is the perfect example of an extremely liquid asset, as it can be used to purchase goods and services directly. A home would be a good example of an illiquid asset, as it can take months to find a buyer who is willing to pay the market price for it.
Slippage is basically a side effect of a lack of liquidity. It's the difference between the expected price of an exchange at the current market rate and the price at which the trade actually happens. For example, someone may want to sell $1 million worth of a particular cryptocurrency on an exchange, but if that individual wants to make the trade quickly, they may have to sell part of their stash at lower than the market rate because there are simply not enough buyers available at the last trade price.
Many cryptocurrencies are easy to transfer around the world in a matter of seconds, but the vast majority of them are also extremely illiquid. As the data from Cryptowatch in the chart above shows, Bitcoin is by far the most liquid cryptocurrency on the market, especially when Tether is excluded.
Ether is the only other non-stablecoin that reaches 8-digits in the Liquid Bids metric. In terms of coins with more than $5 million worth of Liquid Bids, it's just Litecoin, XRP, EOS, and Bitcoin Cash. Liquid Bids are defined by Cryptowatch as the sum of all bid orders within 100 basis points of the best bid across all of the markets tracked by the platform. Liquid Asks are the same concept, applied to the other side of the orderbook. In other words, this data represents the volume of trade offers on the books within 1% of each cryptocurrency’s market price.
If you’re speculating on the price of a crypto asset, then you need to make sure the coin has enough liquidity for you to leave the market when you decide to do so. Most crypto assets are highly illiquid, which means it’s harder to get out of your position without slippage.
The added difficulties associated with moving in and out of illiquid altcoins make them relatively hard to use as stores of value. Are you really holding value if you’re unable to transfer an asset elsewhere without incurring high levels of slippage?
This is not a theoretical issue. The effects of slippage show up in various cryptocurrency-related financial services. In 2017, BitPesa CEO Elizabeth Rossiello noted that she has to be practical about integrating new cryptocurrencies into her company, which has been providing Bitcoin liquidity to individuals and institutions in Africa since 2013.
“If you show me that everybody is using [the coin] and it’s super liquid and there’s no slippage and I have brokers in six of my markets and they’re going to give me liquidity and they’re going to give me a line of credit or whatever it is — let’s do it,” said Rossiello at the time.
Slippage also shows up directly in the fees associated with various cryptocurrency services. For example, crypto lending platform Nexo bases their loan-to-value ratios on the level of liquidity and price volatility associated with a particular asset. Users who deposit Bitcoin are able to take out loans worth around 52.7% of their deposit, while those depositing Stellar Lumens can only borrow around 17% of the value of their deposit. On the online financial platform Uphold, the exchange fees for smaller altcoins, such as Basic Attention Token or Chainlink, are almost twice as much as they are for exchanging Bitcoin.