The ability of an asset to be exchanged or liquidated at a demanded price point.
Imagine wanting to sell your old bike, but no one is responding to your ad. Because time is also a valuable commodity, and you want money for the bike sooner rather than later, this would force you to lower the price for the bike. After all, it would be better to gain some money than none at all.
The same dynamic happens in both the stock and crypto markets. When a seller is not matched by a buyer willing to buy an asset for the price the seller is asking, the market has low liquidity. In turn, such an asset would be illiquid.
The most common illiquid market is real estate. Because the housing sector has to deal with such a wide range of unique propositions, it takes months, and sometimes years, for a seller to be matched with a buyer for an apartment, land, or a house.
In the cryptocurrency market, traders seek those crypto coins that have high liquidity. This enables them to quickly enter or exit the market at wanted price points. There are four main drivers that determine liquidity in the crypto market:
Cryptocurrency exchanges - if major crypto exchanges have listed a particular altcoin, it means its liquidity would drastically increase because the pool of both buyers and sellers would also increase.
Regulations - If a country bans crypto exchanges, as it happened in China and Nigeria. Likewise, an intensely burdensome regulation can stifle trading, as it happened in South Korea. All of these conditions create an environment with fewer avenues to trade, creating a low liquidity market. Such a market distortion in South Korea has been so prevalent that it birthed a new term — kimchi premium. It relates to the large Bitcoin price difference on South Korean exchanges compared to foreign exchanges.
Crypto adoption rate - it goes without saying that the more the public is engaged in the crypto market, it will result in higher liquidity.
Trading volume - the more there are active participants in trading a particular cryptocurrency, the more there will be liquidity. This is why trading volume charts are commonplace on most crypto websites.
BTC price chart with a trading volume beneath as histograms, indicating the number of sell (red) and buy (green) orders at any given day. (Source: TradingView)
As you can see, Bitcoin has very high liquidity because all of its red and green columns, representing trading volume, match to each other. In turn, this is why most traders receive BTC at the market price level.
With that said, Bitcoin is a deflationary cryptocurrency that is often withdrawn from exchanges to cold storage for safekeeping. For this reason, only a couple of million BTC is available for buying or selling at any given time. In other words, over 70% of Bitcoin supply can be said to be illiquid.