Determinants of liquidity in cryptocurrency markets

J. Christopher Westland ()
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J. Christopher Westland: University of Illinois at Chicago

Digital Finance, 2023, vol. 5, issue 2, No 2, 293 pages

Abstract: 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.

Keywords: Liquidity; Two-sided markets; Cryptocurrency; Blockchain; Bitcoin; Glosten-alpha (search for similar items in EconPapers)
JEL-codes: G12 G14 G17 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s42521-022-00073-7

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