Why liquidity is an important indicator in the cryptocurrency market

Trading volume has long been the primary metric cited by analysts, media experts, and collectors to rank cryptocurrency exchanges. Trading volume provides a high-level overview of market activity, but it can be falsified to give the impression that there is more legitimate trading activity in the market than there actually is.

Exchanges may simply print trades that do not exist or allow customers to engage in wash trading (placing buy and sell orders of the same size, same price that immediately cancel each other, creating additional exchange volume that adds no additional volume). It can be encouraged. actual liquidity). Volume can be abused as a vanity indicator that does not provide any meaningful indication of the expected experience of legitimate traders.

Liquidity: the lifeblood of a thriving market

Think of liquidity as the speed and ease with which orders can be filled without affecting the spot price of the asset. As an indicator, it tells participants how easy it would be to execute a trade at or close to the current market price.

We track exchange liquidity using six across the various market health indicators that Kraken monitors.

diffusion

that much The price difference between the highest bid (the price a buyer is willing to pay) and the lowest ask price (the price a seller is willing to pay). Narrower spreads result in better trades because they have lower transaction costs (in addition to commissions) and represent a better agreement on the current market value of the asset.

depth

The relative size and number of open bids and requests at any time. Market depth means that new orders can be filled more easily, reducing the impact on the price of the trade.

Order stability

that much To some extent, market depth depends on the specific time period, especially during difficult market conditions. High order book stability means that orders have a certain level of market impact. This is especially important when volatility is high.

Bid/Ask Imbalance

that much Comparative sizes of bids and asks at a given depth. Imbalances (e.g. bids much larger than asked) create unstable directional liquidity, making asset prices vulnerable to high volatility in one direction.

potential liquidity

that much Market order costs are measured in taker fees. Setting taker fees at an appropriate level ensures that market orders are placed at optimal opportunity cost.

price dispersion

The speed at which an exchange updates its market prices compared to other exchanges. Minimal price dispersion means traders can act on new price information immediately.

How Liquidity Affects Real Trading

High liquidity saves time and money. Like a real physical market, with many buyers and sellers, transactions happen quickly and smoothly. On the other hand, illiquid markets incur opportunity costs. This means that deals take longer to close and are executed at less favorable prices.

This creates a virtuous cycle where liquidity drives trading activity, which drives more order flow and creates more liquidity. Low liquidity increases execution risk, which may deter clients from trading on the platform and may further reduce liquidity.

Liquidity conveys important information that trading volume does not.

As an indicator, liquidity indicates the quality of the trading experience. In other words, it is self-evident to the customer whether the market is liquid or not. If exchanges were ranked by liquidity, there would be no advantage for venues to print fake trades or encourage customers to make fake trades.

It makes no sense to artificially inflate nominal volume figures. It focuses on aligning incentives between exchanges and end users.

Consider liquidity as a byword for market resilience. In illiquid markets, orders have a significant impact on prices, hindering legitimate trading activity. Illiquidity also provides an opportunity for malicious actors to manipulate prices by placing large orders around one depth or price range.

Regulators have previously expressed concerns about cryptocurrency prices being swayed too easily by whales. In liquid markets, large orders are more easily absorbed, preventing disruptive market impacts.

Emphasizing liquidity over trading volume directly incentivizes exchanges to provide a better real-world trading experience that can attract new customers. Wider awareness of these dynamics will result in healthy, thriving ecosystems and markets that customers can navigate confidently and efficiently.