What Is Exit Liquidity in Crypto Markets?
There are a lot of high-level terms used in the cryptocurrency space that don’t always mean what you think they mean. One of these terms is exit liquidity, which is perhaps better known for its association with pump-and-dump schemes.
Exit liquidity is another word for how easy it is for an investor to exit their investment position at any given time. Read on to learn more about exit liquidity and how this term applies in the cryptocurrency market.
What is Exit Liquidity?
Exit liquidity is a little bit of a complicated topic to explain because there are so many ways to create it. Overall, it is a term that specifies how easy it is for an investor to exit their position without harming the market or the asset itself. Basically, if selling or closing a position would devalue an asset (or if it would be difficult to do so), the people holding the asset currently would have bad exit liquidity.
However, there is another meaning to this word, and this happens when you become someone’s exit liquidity. Meaning you are the buyer who is buying an asset so someone else can exit the market. This is specifically what individuals look for when executing pump-and-dump schemes. They want people to invest and drive hype early on, so that the price balloons and they can exit for more money than what they paid to invest.
How is Exit Liquidity Measured?
There is no exact way to measure the exact exit liquidity of an asset, however estimations are made based on the following aspects:
Order Book Depth
How many people want to buy into the asset? If there are more offers to buy than to sell, then the order books are considered deep and the exit liquidity is high.
Market Sentiment/Demand
How does the market feel about the asset? If they are overwhelmingly positive, then the exit liquidity is high, as it is assumed that it will be easy to find buyers at any given point.
Are There Market Makers?
Market makers keep the investing world moving by allowing individuals to buy and sell assets without having an exact match or trade. If market makers carry an asset, it is a good sign that the exit liquidity is high, as the investor can leave at any point. The more market makers there are, the higher the exit liquidity.
Using these three metrics of measurement, investors can estimate exit liquidity. As we mentioned above, there is no exact science, and at any time the exit liquidity of any asset can change—especially if media articles are published and go viral.
Why Does Exit Liquidity Matter?
Exit liquidity matters because it is not a good thing for those who become exit liquidity for someone else. We researched long and hard for this article, and were unable to find instances where we considered exit liquidity to be a positive thing, as it almost always leads to someone holding the bag.
Basically, if someone tells you an asset has high exit liquidity, while this might sound positive, you should scrutinize their words carefully—because if they are trying to convince you to buy said asset, it is a sure sign that they are trying to convince you to become the exit liquidity.
There is a faction of investors out there who create products for the purpose of driving hype and then exiting, and these are known as pump and dump schemes. These creators invent products for the sole purpose of hyping them up before selling their shares and making a profit. Hopefully, we don’t have to explain to you that this is deceitful and wrong, and you came to that conclusion on your own.
That being said, there are some instances where exit liquidity is unintentional, typically in the NFT space. Many individuals buy NFTs because they like the art, the artist, or want to collect aspects of a certain collection. Later, they may see the value rise and decide to sell their art or collection. In this case, they may sell at a price higher than what they bought, only for the art to fall out of popularity later on, leaving the buyer with a worthless NFT they bought at a high price. Although this is also unfortunate for the buyer, in many cases, this is done unintentionally, and this is not considered a pump-and-dump scheme (unless the inventor of the NFT advertised the product to drive hype specifically for exiting).
The reason the second case is considered unintentional is because this happens in the real world with art and collectibles as well. Just look at Beanie Babies, Pokémon cards, and paintings. While some of these artworks have held their worth more than others (like the Mona Lisa, for example, and anything by Banksy), Beanie Babies have since crashed and burned, leaving people with collections that are essentially worthless. But, of course, this was not intentional, as Beanie Babies were popular and were worth a lot of money, however times, and collectors, changed.
How Can You Tell If You’re Becoming Someone’s Exit Liquidity?
Unfortunately, there is no way to know for certain that you are becoming someone’s exit liquidity. Especially because, as mentioned above, it isn’t always intentional. However, below are some red flags you should watch out for.
· Someone who is already invested is pushing hard for you to invest (remember, if it was really that good of an investment, people wouldn’t share that willingly and would buy more themselves)
· You can’t find any information as to why the asset is valuable (i.e., there isn’t a platform or technology you are funding)
· The media features the product heavily, but real investors you trust (i.e. Warren Buffet or Mark Cuban) are hesitant
· The asset is something physical that could go out of fashion
· Sudden, unexpected price spikes that can’t be explained by natural company growth
Honestly, if you see two or more of these red flags, it’s best not to invest.
All in all, exit liquidity (in our opinion) isn’t a good thing unless you are the person using someone else as said liquidity. If that is you, it may be a time to look at your morals and ask yourself if harming someone else is truly worth the cash.
