Many people understand liquidity as how quickly you can sell an asset. Assets that are very liquid (cash for example) can be sold very quickly while assets that are very illiquid (such as property) take an extensive amount of time to sell. However, this isn’t exactly correct. It’s true that liquidity measures how quickly an asset can be sold BUT that definition is missing the most important aspect. Liquidity measures how quickly an asset can be sold without a drastic change in the asset’s price. You may have trouble selling your car within a day at market value, but if you offered to sell it for 90% off you could sell it within a couple of hours. For this reason, a car is considered to be an illiquid asset.
Everyone wants to be able to sell an asset whenever they want without forfeiting the market value, but this simply isn’t possible. This chart below shows a brief (and VERY simplified) example of how liquid different assets are considered to be. Take note that assets with high liquidity are generally less risky, while low liquidity assets tend to be more risky investments.
As you can see, both cryptocurrency and art are considered to be the least liquid assets. Based simply on this, we can make an educated guess that an NFT (being a mix of both crypto and art) would fall under this category, or might even need a new category for itself. Art (including collectibles) is very illiquid because not everyone is drawn to the same style or artist, and even if you find a buyer you may not agree on the value. Cryptocurrency is considered illiquid largely due to the volatility of the overall cryptocurrency market. There are often days/weeks where there is tremendous volume and prices are rising, and there are also days/weeks when the opposite is happening. Liquidity must constantly be reassessed as the markets move, leading to an overall illiquid market.
Now that we have outlined how both crypto and art/collectibles are illiquid, it is much easier to understand why an NFT is considered to be extremely illiquid. This stance can be broken down into 3 main considerations: finding the right buyer, agreeing on a value, and timing the purchase. This article will take the stance of someone looking to sell Bored Ape #9658.
Consideration 1: Finding the right buyer
It’s no surprise that because NFTs are still gaining traction there isn’t a massive market of buyers. In a market that is still in its beginning stages and has yet to be widely adopted, finding the “right” buyer (not just any buyer) becomes very tricky. In order for someone to be the “right” buyer they must be willing to buy your asset and have enough money to do so. Many people may be willing to buy a Bored Ape (or any blue-chip NFT for that matter), but don’t have 75 Ethereum sitting around to do so. This narrows down an already limited buyer pool and makes this NFT even more illiquid.
Consideration 2: Agree on value
The next step is that both parties agree on the value of the Bored Ape. This is the step where most purchases fail. If a buyer only values this Bored Ape at 70 eth but you value it at 75, the NFT will not be sold. Sometimes a buyer may really want the asset and is willing to pay a bit more than they want to, or a seller really wants to sell the asset and will sell for less than they were originally hoping for. It’s important to reiterate that liquidity is contingent on keeping the market value of an asset. NFTs are so illiquid in part because bid/ask prices may vary so much and collectors do not always agree on value. This in turn makes it more difficult to quickly sell your asset at its market value.
Step 3: Timing the purchase
Because the NFT market is so volatile and rarely sees any form of stability, timing can be something that many collectors focus on. In a matter of hours a project’s floor could moon, or be decimated by bad news. Collectors may try to “time” a purchase by waiting until new news comes out about a project, the floor price drops, the price of crypto falls, etc. As there is no set rule or guideline for what to expect, many collectors have their own preferences on when they want to purchase an NFT. Even if you have found the “right” buyer and an agreed-upon value, a buyer may be hesitant to purchase based on market conditions (this could be either the crypto market or the NFT market in this case). This is yet another factor that attributes to NFTs being so illiquid.
A brief summary of the considerations
Because the NFT market is still in its infant stage, the market for buyers is small and therefore it is difficult to quickly find buyers.
Many collectors value different aspects of an NFT differently (art, utility, community, etc.) which can lead to difficulty in agreeing on a price.
With such a volatile market, many collectors find themselves hesitant to purchase based on the current conditions.
While these three steps may seem demanding and complicated, in most cases they happen in a split-second decision from the buyer. When listing your NFT on a marketplace such as OpenSea or LooksRare your work as a seller can be finished when your listing is posted. Potential buyers will be able to search what they are looking for, and make the purchase with the click of a few buttons.
While there are more factors influencing the liquidity of NFTs, these are a few of the most prominent as of now. Many investors choose to balance their portfolio with assets of varying liquidity so they are not caught in a bad spot if the markets sway one way another. It’s important to understand what liquidity is and how it impacts your portfolio so that you can measure your risk and have a plan.