Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. Crypto projects will list their tokens on centralized (CEX) and decentralized (DEX) exchanges and provide liquidity to support the efficient trading of the token.
On CEXs, the exchange will manage the liquidity of the token from the supply provided by the project. However, on DEXs like automated market makers (AMMs) the project is responsible for providing sufficient liquidity for the trading of the asset. Liquidity is usually provided on a 50/50 split between the project’s token and another trading pair such as a stablecoin or the native coin of the blockchain such $ETH or $BNB.
The more liquidity provided, the less price slippage there will be when people trade the asset. Price slippage is the difference in price paid vs the market price of the token when the buy or sell order was placed. Projects will incentivize projects to provide liquidity on a DEX in order to aid in price support in return for staking or liquidity provider (LP) rewards. The amount of liquidity allocated in the tokenomics and whether that liquidity will be locked are key indicators of the project’s long-term commitment to the project and its token holders.
The amount of funding received by the project is also a strong indicator of the project’s ability to survive market downturns. Projects with strong backers and funding will be better positioned to support the project and the token over the long-run.