Why liquidity is a vital metric in crypto markets

Buying and selling quantity has lengthy been the default metric cited by analysts, media pundits and aggregators to rank cryptocurrency exchanges. Whereas quantity supplies a high-level overview of market exercise, it may be faked to create the impression there’s extra legit trading exercise on a market than there actually is. 

The alternate can merely print non-existent trades or they will incentivize shoppers to interact in wash buying and selling (the position of purchase and promote orders in the identical measurement on the similar value that immediately cancel one another out, creating further alternate commerce quantity that provides no precise liquidity). Quantity could be abused as a conceit metric that doesn’t provide a significant indicator of a legit dealer’s anticipated expertise.

Liquidity: The lifeblood of any thriving market

Consider liquidity because the pace and ease with which orders are stuffed with out impacting an asset’s spot value. As a metric, it tells individuals how simple it’s to execute trades both at or near the present market value.  

Throughout the assorted market well being metrics that Kraken displays, we use six to trace alternate liquidity:

Unfold

The value distinction between the best bid (value a purchaser is prepared to pay) and lowest ask (value a vendor is prepared to take). Tighter spreads make for higher buying and selling as a result of they imply a decrease price of buying and selling (past simply charges) and symbolize a greater consensus on an asset’s present market worth.

Depth

The relative measurement and variety of open bids and asks at anybody time. Market depth means new orders could be extra readily stuffed, decreasing influence to the buying and selling value.

Order ebook stability

The diploma market depth varies throughout a given time interval, however significantly throughout distressed market circumstances. Excessive order ebook stability means orders have a constant stage of market influence. That is significantly necessary when volatility is excessive.

Bid/ask imbalance

The comparative measurement of bids and asks at a given depth. Imbalances (e.g., a lot bigger sized bids than asks) create unstable directional liquidity, leaving an asset value prone to excessive volatility in a single course.

Latent liquidity

The market order price measured by taker charges. Setting taker charges on the proper stage ensures market orders could be positioned on the optimum alternative price. 

Worth dispersion

The pace at which exchanges replace market costs relative to different exchanges. Minimal value dispersion means merchants can act promptly on new value info.

The actual-world buying and selling influence of liquidity

Excessive liquidity saves money and time. Like an precise bodily market, transactions happen swiftly and seamlessly if there are many patrons and sellers. On the flipside, illiquid marketplaces incur a possibility price: transactions take longer to fill and get executed at much less favorable costs.

Due to this, liquidity additionally encourages buying and selling exercise… which ends up in extra order circulate… which creates nonetheless extra liquidity: a virtuous cycle. Low liquidity can create a better execution danger that daunts shoppers from buying and selling on the platform, additional decreasing liquidity.

Liquidity communicates necessary info that quantity doesn’t

As a metric, liquidity speaks to the standard of the buying and selling expertise: It’s self-evident to the consumer whether or not a market is liquid or not. If exchanges have been ranked by liquidity, there’d be no profit to venues printing faux trades or inducing shoppers to scrub commerce.

There can be no level to artificially inflating nominal quantity numbers. The main target can be on aligning incentives between the alternate and the top person.

Take into account liquidity as a byword for market resilience. In an illiquid market, orders have a big value influence, which discourages legit buying and selling exercise. Illiquidity additionally supplies alternatives for dangerous actors to control costs with high-volume orders round one depth or value level.

Regulators have beforehand expressed concern that crypto costs are too simply swayed by whales. In a liquid market, giant orders are extra simply absorbed, stopping disruptive market impacts.

Emphasizing liquidity over buying and selling quantity would immediately incentivize exchanges to supply a greater sensible buying and selling expertise to draw new shoppers. Wider consciousness of those dynamics will yield a wholesome, flourishing ecosystem and marketplaces that shoppers can confidently and effectively navigate.