Liquidity is an important financial indicator of how quickly and easily one asset can be converted into another without significantly affecting the stability of the spot price. High liquidity can:
- prevent market fluctuations;
- increase the stability of the crypto exchange;
- build trust between traders;
- ensure a fair and equal price for all market participants.
The higher the liquidity of an exchange, the more profitable it is: more liquidity means there are more traders who conduct more transactions.
Liquidity aggregation is a process in which offers from different sources to buy and sell an asset are combined and sent to the executor in order to provide traders with the opportunity to buy an asset at the best price.
This is how it works: cryptocurrencies are known for their price volatility, so the price of the same asset on different exchanges often varies significantly. If a trader is not satisfied with the price of a particular cryptocurrency, he can switch to another crypto exchange — this is the crux of liquidity aggregation.
Spread expansion
The word “spread” means “difference, scope,” and this captures the essence of the term very well. In regard to an exchange, a spread most often shows the difference between the selling and buying prices of an asset (the selling price is always lower).
Another related concept is the “depth of market”, or a table that shows all the selling and buying prices of an asset, as well as its quantity. Liquidity can be determined from the spread and the depth of market – the smaller the spread, the more liquid the asset.
Slippage effect
When a broker is unable to provide sufficient liquidity, slippage will occur more frequently. This happens when the price at which the transaction was made differs from the price expected by the trader. Of course, no one wants to be disappointed in their expectations.
How does slippage occur? Let’s look at an example. Suppose a trader placed a buy order for $50, but due to the lack of liquidity on the trading platform, the broker fails to satisfy the request in full. Then he’ll have to accept the following orders at a price higher than $50. As a result, the average purchase price will be above the initial $50.
The slippage effect also depends on an asset’s price volatility. For example, cryptocurrencies are characterized by extremely high volatility. But it’s impossible to protect yourself against volatility, since changes are unpredictable and can have a number of underlying reasons. Thus, it’s essential for a broker’s clients to trade on highly liquid platforms.
Sharp price fluctuations
A “gap” is another term that constantly accompanies a low-liquid trading floor. In a regular sense, a gap is a sharp fluctuation in the price of an asset. If a trader is lucky, the effect will play in his favor. But, as in the case of slippage, the result is most often negative and leads to losses.
In technical analysis, a gap is a significant difference between the closing prices of the previous timeframe and the opening of the next. You can visually see it on the quote chart shaped as a gap. A gap usually occurs in non-trading time. But when it comes to a non-liquid market, the situation worsens due to a mismatch between demand and supply and vice versa. In this case, the phenomenon is unpredictable and affects income.
