Liquidity is the degree to which an asset or security can be quickly bought or sold in a market without affecting the asset’s price.
Market liquidity refers to the extent to which a market, such as a country’s stock market or a city’s real estate market, allows assets to be bought and sold at stable prices. Of course, cash is the most liquid asset, whereas real estate, fine art and collectibles, and particularly, early stage private equities are all relatively illiquid.
If an exchange has a high volume of trade that is not dominated by selling, the price a buyer offers per share (the bid price) and the price the seller is willing to accept (the ask price) will be fairly close to each other. Investors will not have to surrender unrealized gains just for the purpose of obtaining a quick sale. When the spread between the bid and ask prices grows, the market becomes more illiquid.
Higher liquidity alleviates the trade-off between the price of an asset it can be sold/bought for and the speed of its sale. People have preference for liquidity as demonstrated by the theory first introduced by John Maynard Keynes. Many theories and empirical studies suggest that lower liquidity results in underrated value stored in assets.
Making assets more liquid will help unlock their underlying value. A share of stock that’s traded on an exchange is of higher value than a share of stock in an identical private company because there is less friction to trade the public stock. Less friction often means more market participants, more volume, smaller spreads, and less price impact.
How big is the illiquidity discount? Financial economists have attempted to measure the illiquidity discount in a variety of ways. A common rule of thumb is 20–30%. This represents a huge amount of value and therein lies great promise.
Tokenizing assets on XDEX will increase their overall value through the improvement of liquidity for buyers and sellers.
