Understanding liquidity

To understand liquidity, it is helpful to first discuss volatility.

Volatility measures how much an asset price changes as the market moves from one state to another over time.

Liquidity refers to how easily an asset can be bought or sold without causing a significant change in its price. When a market is difficult to access or when there is a large price gap between buying and selling (a wide bid–ask spread), price movements tend to be more aggressive, resulting in higher volatility.

Liquidity is traditionally provided by market makers or market owners who deploy large amounts of capital. In crypto markets, however, individuals can also provide liquidity by supplying token pairs to smart contracts in liquidity pools. This structure allows crypto markets to be self-sustaining, but it also explains why they can sometimes exhibit extreme volatility when liquidity is fragmented or withdrawn.

To measure market volatility, one approach is to use Euclidean distance, which quantifies how far the market moves in n-dimensional Euclidean space (a physical-space representation of market variables). The resulting distance can be interpreted as a measure of similarity or dissimilarity between market states.

Each market condition can be represented as an n-dimensional vector:

x = (x₁, x₂, x₃, ..., xₙ)

The Euclidean distance between two market states x and y is:

d(x, y) = sqrt( sum( (xi - yi)^2 ) ), for i = 1 to n

Parameters that can be used to measure similarity as n-dimensional vector includes:

• Time delta between candles or events
• Historical volatility (e.g., standard deviation of returns)
• Price range (high–low)
• Momentum indicators (rate of change, RSI, MACD represented numerically)
• Order flow or market imbalance (if data is available)
• Liquidity metrics or bid–ask spread
• Open interest (for derivatives markets)

Because these parameters have different scales, normalization is typically applied to ensure no single dimension dominates the distance calculation.

As the Euclidean distance between market states increases, the market dissimilarity is higher, indicating higher volatility while stable distances suggest a liquid and structurally stable market.

Price volatility often triggers liquidity-driven events which includes:

• Liquidation cascades: chain reactions where forced liquidations trigger additional liquidations, rapidly driving price toward areas of concentrated liquidity.
• Stop-loss hunts: movements into zones where liquidity is concentrated, allowing large participants to access the liquidity.
• Large player positioning: entries or exits by institutional or high net-worth participants with size.
• News-driven reactions: sharp price moves caused by market responses to news, which may be delayed or frontrun by informed participants.

In the short run, the market is a voting machine, but in the long run, it is a weighing machine. Liquidity provides the ink for the vote, but value provides the weight for the scale - Benjamin Graham

Trade the attention in short-term market, trade the value in long-term market.

Kingmaker the attention frontrunner.