What is Liquidity? How Does Liquidity Impact Alternative Assets & Collectibles?

January 26, 2023
Altan Insights

What is liquidity?

When used in reference to market dynamics, liquidity is the efficiency or ease with which an asset can be liquidated (put differently: sold for cash) at market prices or without significantly impacting market prices. Markets that are liquid are characterized by very active participation from a large number of parties. The stock market, for example, is generally said to be quite liquid, as participants can very often liquidate their holdings at or very near to the prevailing market price. This is not necessarily true of all stocks, but for the purposes of illustration, consider the well known, mega cap names like Apple, Alphabet, or Microsoft.

An illiquid market, then, is one without active participation and a large number of participants. In this type of market, where liquidity is low, you might expect that when you want to liquidate your asset, you may have to do so at a significant discount to prevailing fair market value in order to entice a willing buyer. In effect, you’re making a tradeoff between the value you’ll realize and the speed with which you’ll realize it. 

How does liquidity affect collectible markets? 

Liquidity can play a significant role in a collector’s success or failure in realizing optimal value for their collectibles. Many collectible markets are beset by low liquidity, and that’s especially the case in times of stress, but relative to more efficient markets like stocks, liquidity is persistently quite low.

Consider what you have to do to sell a collectible asset. There isn’t an active exchange that operates with specific hours that sees millions of traders ready to do business. Instead, you have to list the asset, either with an auction house or on a marketplace, and you either wait for the auction to end, or you wait for a buyer to surface. Sometimes this can be quick and painless, others not so much. Under regular circumstances, you might hope that your asset transacts at the same level as a recent transaction for an identical or near-identical asset. This would be the hope in times of higher liquidity. 

In times of lower liquidity, sellers have to settle for whatever their asset will fetch at auction or whatever offer they receive if they’re motivated to sell, and generally, that will be at a lower price relative to recent results. When various collectible markets were melting down in the summer of 2022, there were still sellers motivated to liquidate their assets against a backdrop of low liquidity. The buying pool was growing smaller and less motivated each day. More than ever, yesterday’s price was not today’s price. 

How does liquidity affect fractional collectible markets?

While fractional collectible markets are intended to function more like the stock market in structure, the young age of the concept and the marketplaces means there isn’t nearly the same sizable audience, and that audience isn’t nearly as active in trading. So, much like in regular collectible markets, when things go south, the impact can be amplified by low liquidity.

For example, shareholders in an asset may see that an identical asset just sold for $60,000 at auction. Seeking an exit from the asset, they may place an ask for a share price that values the fractional asset at $60,000. Due to low liquidity though - a lack of bidding activity - there may be no interest whatsoever on the buy side of that transaction. So, the seller is then forced to lower the price if they want out, and there are no guarantees as to what level (if any) may motivate buyers. In a more liquid market, there might be a larger pool of buyers more quickly motivated by a disconnect in value between the fractional asset and its real world counterpart. 

In the absence of solid liquidity, fractional shareholders may be forced to hold onto an asset they’d prefer to liquidate, rather than realize a significant loss that values the asset well below the market.

What challenges does low liquidity present to collectibles as alternative assets?

Illiquidity can introduce many challenges for any asset class. In some asset classes, illiquidity is a forced constraint, as vehicles like hedge funds and private equity funds have differing liquidity parameters allowing customers to redeem quarterly (in the case of hedge funds) or after as much as 10-15 years (in the case of PE). 

There is no imposed constraint in collectibles, but perhaps collectors would be wise to impose constraints upon themselves in certain cases. The illiquidity in collectible markets means that timing sales is perhaps even more important than it is elsewhere. Liquidating assets in times of stress can create dramatically different outcomes than doing so in more stable moments, often for the worse. 

It can also make evaluating sales and sales data challenging. Outlier sales may result from moments of very low liquidity, and that can make it difficult to understand the value of one’s asset and how it performs over time. 

Can liquidity in collectible markets improve?

Liquidity in collectible markets is consistently improving and has improved leaps and bounds in recent years. These markets are the most liquid they've ever been. Significant investment has flowed into collectible markets, leading to competition and important innovation. More than ever before, it’s possible to purchase and sell collectible assets with reduced friction, and stakeholders continue to reduce that friction. For example, markets now boast a greater frequency of auctions, more marketplaces, vaulting services, lending solutions, fractional investing, and more. Essentially, innovation is focused on lowering the various barriers to transacting. 

Ultimately though, while those measures are indeed helpful, at some point, improved liquidity will rely mostly upon increased participation. The degree to which that occurs is anybody’s guess.

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