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Determinants of liquidity in cryptocurrency markets

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  • J. Christopher Westland

    (University of Illinois at Chicago)

Abstract

This research identified predictors of cryptocurrency liquidity and explored whether cryptocurrency is a true cash equivalent. Liquidity is important because cryptocurrencies aim to be cash substitutes, and thus totally liquid. Greater liquidity is correlated with more profitable trading, better price discovery; and more profitable market operation. The research tested five hypotheses concerning liquidity and its predictors, for a set of cryptocurrencies that represent ~ 90% of volume and market capitalization, thus are generalizable. Price was strongly supported as a predictor of liquidity, while volume was not. Fungibility, in the sense of ‘mutual interchangeability of particular pairs of cryptocurrencies, was not found to be a good predictor of liquidity, leading us to question whether cryptocurrencies can truly be considered ’cash equivalents’. I also tested whether price and volume embedded in own-price elasticity was a predictor of liquidity, and rejected this hypotheses. Finally, an analysis involving step-wise regression unambiguously selected a combination (3) daily volume, and (4) own-price elasticity. Explanatory power was somewhat better than other predictors, allowing future research to incorporate these findings to construct better models of liquidity in blockchain-enabled markets.

Suggested Citation

  • J. Christopher Westland, 2023. "Determinants of liquidity in cryptocurrency markets," Digital Finance, Springer, vol. 5(2), pages 261-293, June.
    • Handle: RePEc:spr:digfin:v:5:y:2023:i:2:d:10.1007_s42521-022-00073-7
    DOI: 10.1007/s42521-022-00073-7
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    More about this item

    Keywords

    Liquidity; Two-sided markets; Cryptocurrency; Blockchain; Bitcoin; Glosten-alpha;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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