Crypto Exchange Liquidity and How it Enhances Traders' Experience

Have you ever wondered why Bitcoin currently has a market value of $69,000 with an average number of 700,000 active trades occurring daily? Or why the Binance platform has over 170 million users all over the world?

One word – liquidity.

The liquidity of a crypto exchange and not just the crypto asset, contributes immensely to the effectiveness and performance of the platform. Would you like to know how it works?

In this article, we will explain crypto exchange liquidity, how it impacts the platform’s performance and in turn, the user experience for traders. We will also look at the challenges it faces and how it can be improved.

What is Liquidity and Why Is It Important?

Think of liquidity as the “fluidity” of assets, i.e., how an asset can become fluid or change from one form to another.

It refers to how easily you can convert an asset to another desirable form, cash. This concept is very important as it determines whether or not a crypto asset or the market, in general, is desirable for trading.

In other words, high-liquidity assets are those you can trade (i.e., convert to cash) easily because a lot of buyers and sellers like yourself are present in the market anytime you want to trade. While illiquid assets are harder for you to trade because there aren’t a lot of buyers and sellers.

Crypto Asset Liquidity vs Crypto Exchange Liquidity

Crypto liquidity can be divided into two categories: crypto asset liquidity and crypto exchange liquidity.

Crypto Asset Liquidity:

When it comes to assets, liquidity means that a lot of people are buying and selling something and the price or underlying value of those things are not changing. Bitcoin, Ethereum, Ripple, LiteCoin, Solana, and other examples come to mind.

Crypto Exchange Liquidity:

In terms of crypto exchange, liquidity means that the exchange can accommodate a large volume of trades on the platform without significantly affecting the market price. Examples include Binance, ByBit, OKX, Kraken and Coinbase exchanges.

Going further, we will be focusing on crypto exchange liquidity. Now, let’s explore what makes liquidity important in a crypto exchange.

Significance of Liquidity in a Crypto Exchange Platform

Generally, high liquidity in a crypto exchange improves the performance of the platform, and when it does, it directly benefits the traders using that platform. Let’s look at four ways it does this.

Significance of Liquidity in a Crypto Exchange Platform

High liquidity means there are a lot of active buyers and sellers in the market. This means that you don’t have to wait too long before you buy or sell an asset as there is active participation in the market already. You would find that this is very beneficial in a volatile market where prices change very fast.

Better Pricing:

Assuming you want to sell an asset in the marketplace for a price that is close to market value, a highly liquid crypto exchange will make it possible as there will be multiple offers from buyers for prices close to your desired sell price. This is known as a tight bid-ask spread.

Market stability:

When there is a high volume of trading activity or liquidity in a crypto exchange, huge orders are less likely to create unexpected price fluctuations.

Market stability:

The cycle continues because a liquid crypto exchange will attract more investors and traders, and as more people join the platform, liquidity increases even more, benefitting everyone on the platform.

Factors Responsible for Crypto Exchange Liquidity

Several factors influence the liquidity of a crypto exchange:

• Number of Participants: As previously stated, the number of active traders on a cryptocurrency exchange determines how liquid or illiquid it is.
• Trading Volume: The trading volume of assets on the cryptocurrency exchange is another sign of liquidity. Higher trade volumes suggest a more liquid market, as there are more buyers and sellers.
• Market circumstances: Market circumstances and economic considerations have a big impact on liquidity. During times of market uncertainty or economic downturns, liquidity can swiftly dry up as traders become more cautious and reluctant to buy or sell. In contrast, during moments of high market sentiment, liquidity may increase as more participants enter the market.
• Liquidity Providers/Market Maker Presence: By constantly placing both buy and sell orders, these individuals profit from the spread between prices, maintaining a continual flow of assets.

Challenges to Achieving High Liquidity in Crypto Exchanges

Crypto exchanges also face challenges when trying to achieve maximum liquidity:

Segmentation: This is a problem because every exchange operates individually, and is trying to attract traders to its own platform. Therefore it can be difficult for any one platform to attain high liquidity.

Liquidity Gaps: Due to the volatile nature of cryptocurrencies, anything can happen at any time and cause a drop in the price of assets at market value.

Regulatory Uncertainty: When the rules and regulations surrounding cryptocurrencies are not clear, it poses a serious problem. Laws in countries that ban certain crypto assets will also affect liquidity.

Blueprint for Improving Crypto Exchange Liquidity

Ensuring liquidity for crypto exchanges isn’t a passive process; exchanges must be proactive and intentional to meet their goal. Let's look at four different ways they can accomplish that.

Partnerships with LPs: One way is to partner with major banks or payment gateways; this way their involvement enhances liquidity.

Market Maker Programs: Market makers provide liquidity to the market by placing orders. By incentivising them through special programs, they'd be more willing to do their jobs.  

Enhanced Trading Features and Bonuses: Adding advanced features such as NFTs, DeFi and passive income opportunities will attract traders to a crypto exchange.
Listing Popular Coins and Tokens: Listing popular or trending currencies will also bring traders to an exchange platform.

Final Thoughts

If you are thinking of starting a crypto exchange or joining one, then you should pay attention to this.

Proof-of-Reserves (PoR).

Proof-of-Reserves (PoR) is an idea that aims to make the reserves that a cryptocurrency exchange says it has clear and transparent to the public.

To do this, the exchange has to make sure that the number of digital assets it holds for its customers fits the number of assets it claims to own. When an outside auditor checks a POR, they look at the exchange's assets and bills to make sure they match up.

The results of these audits are then made publicly available for verification.

Ensure you keep an eye out for these audits when doing your research!

FAQs

Q1: Which crypto exchanges have the most liquidity?

Binance, Coinbase, OKX, and Bybit are the top cryptocurrency platforms.

Q2: What is the best crypto liquidity provider?

There is no one “best” crypto liquidity provider, but some well-known providers as of 2024 include, GSR Markets, Empirica, Galaxy Digital Trading and B2Broker.

Q3: Why is liquidity crucial for crypto exchanges?

Liquidity guarantees that transactions are completed on time and at a fair price, attracting additional traders while ensuring market stability.