How do crypto and #web3 assets leverage liquidity and how this drives value

How do crypto and #web3 assets leverage liquidity and how this drives value:

In economics, a liquidity premium is the explanation for the difference between assets, that have the same traits except liquidity. Usually, a liquidity premium will imbue the asset with liquidity a higher price than the one without.

This is intuitive; as investors are able to move in and out of these assets more easily. This gives them confidence to buy in and take larger positions thus driving liquidity.

Now market makers have gotten a bad rep in the space, but they are simply large traders who provide liquidity to other traders who prize instant settlement and are willing to take a discount to the current market. They also face significant risk such as volatility & illiquidity.

Due to the 24/7 nature of web3 and the ability for these assets to be traded without friction across the world instantly; the trend is for more and more liquidity to move into these markets. This is termed as “liquidity chasing liquidity”, and is a self reinforcing mechanism.

However, as liquidity dries up; the reverse is also true. This leads to spiralling prices as sellers seek to find the next liquidity floor.

Now, you can tell the maturity of the market by the amount of liquidity it has in it. With greater liquidity comes greater price discovery. And in a way; this lack or excess of liquidity can show investors which markets potentially have high risk reward outcomes.

Look out for markets also which inherently have difficulty attracting liquidity either structurally or temporarily; and place your chips accordingly.

Structurally problematic markets will often stay that way for years and asset prices can stay lower for far longer than you expect. Temporarily restricted markets could be a good source of alpha.

Ensuing liquidity waves into an asset class is a good thing to watch out for.

#nfts and #ens are clearly two markets which are positioned to capture a greater portion of the world’s liquidity. The liquidity premium can be seen in the difference between the digits and all other categories. There is good risk reward in other categories as a result.

However; that risk reward calculation will be firmly expressed in the current liquidity premium.


Link to original tweet: