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Hyypia, 47, arrived from Willem II in 1999 for a fee of £2.6m and spent 10 years at Anfield.
During his decade-long stay at Liverpool, Hyypia played an important role in the Reds' treble-winning 2000-01 season as the club captured the FA Cup, League Cup and UEFA Cup.
Hyypia, who was also captain for Liverpool, made over 300 appearances for the Reds before signing for Bayer Leverkusen in 2009.
Carragher hailed the impact of former teammate Hyypia and suggested that Liverpool transformed from a "soft touch to a team that was mentally and physically very strong."
Speaking on Monday Night Football, the Liverpool legend explained: "This is not who the best player is, this is pound-for-pound.
"And the reason Hyypia is on that list is because when I think of where Liverpool were in 1999, they were a team finishing sixth and seventh in the league.
"That team was known as a weak team, got bullied. He [Hyypia] came in and over the next ten years, he was never injured, and Liverpool went from a soft touch to a team that was mentally and physically very strong and he was a massive part of that.
"The success we had with Gerard Houllier and Rafael Benitez was built on defence. It was built on solidity and that was built on his signing.
"The price tag, the never being injured, the ten years of service and the trophies that he won, that's why he's top."
Carragher also picked Luis Suarez, Andy Robertson, Virgil van Dijk and Salah in his top five.
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