I've tried to write this post a couple times and I've never made it through, but it's an important topic that I've had at the back of my mind almost constantly these past few years so it's about time I put pen to paper. It's about what we call "liquidity."
Liquidity is a phrase you hear often in the crypto space. Whether it is used to refer to the ability to buy into a project (e.g. to have "liquid" to "ape-in"), or whether it is the availability of enough tokens on either side of a swap, liquidity is what makes the coins and jpegs go 'round. Sometimes I wonder why we call it liquidity, when its nature is more akin to oxygen, because without it you die.
For tokens to have value in relation to each other, there need to be liquidity providers (LPs) that pool their tokens across two pairs (e.g. $Degen and $ETH), so that people who want to trade between them are able to buy/sell. The more demand a token has over its counterpart in the pair, the higher the price (and for the LP, the more impermanent loss) results.
Liquidity crises happen when there is an imbalance between supply and demand across two pairs of tokens. If folks clearly want to hold token A over token B, the price of token A will rise in relation to token B. Bad news for token B holders, as not many token A holders would want to sell their tokens for token B. This causes token B to have a lower price compared to token A, if any price at all.
When you receive an airdrop, or buy into a new memecoin, it's important to always consider the liquidity situation you are getting yourself into. Questions such as:
Who are the buyers, who are the sellers?
Why are they buying or selling?
Where is the liquidity coming from?
What is driving the demand?
What (if any) supply unlocks will happen in the future?
At what price would I sell? At what price would I buy more?
The third question above is especially important to think about. Liquidity for you to enter an asset, or exit an asset, is created only by someone making the exact opposite trade. When you are selling, someone else is buying. When you are buying, someone else is selling. In a positive-sum situation, depending on the buyer/seller's time horizon or trade strategy, both the buyer and seller could consider a particular trade as fruitful. However, in a zero-sum situation, there ends up a very clear right and wrong choice. Someone will gain, and someone will lose.
With memecoin season underway, it can be fun to receive airdrops and watch charts climb. But as you track your paper profits, it's worth deciding a realistic timing at which you will sell and realized those profits, lest you round-trip your gains. Because at the end of the day, you and I are the liquidity, and in crypto the tide can move quickly. Stay safe out there!
