Liquidity as the Key Aspect of the Crypto Market Quality

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Liquidity as the Key Aspect of the Crypto Market Quality
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Calculating the Slippage

If your Buy order matches with the likewise Sell order of someone else, it executes immediately. This means high liquidity. However, if the exchange has low liquidity, you might encounter unfavorable price slippage. Let’s see how it works.

Example:

A trader’s order to buy 1 BTC for $40117 matches with 1 BTC-sell at $40117.

This suggests no slippage at all.

That’s good liquidity.

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If the liquidity is lower, the order might be filled with a few smaller orders. In this case, the slippage may occur if the prices of the latter vary.

For example, a trader wants to SELL 1 BTC.

The order book BTC/USD of the Sell side looks like this:

0.05 – $39,963.4

0.25 – $39,938.3

0.6 – $39,935.4

0.1 – $39,911.2

So their order for 1 BTC fills with these 4 smaller orders.

The average price at which it will execute is this:

0.6*39,935.4 + 0.1*39,911.2 + 0.05*39,963.4 + 0.25*39,938.3 = $39,935.1

After this order, the price of BTC will fall to $39,935.1 because the trader took all the orders for a better price. In case if the exchange has a low liquidity there won’t be many traders who offer the better price in the nearest time.

Also, let’s calculate the slippage for this order. The best price in the order book minus the price at which the order was filled.

39,963.4 – 39,935.1 = $28.3 slippage

The prices for different orders have up to $51 variance. That’s a lot. As we can see, such a difference led to a decrease in BTC price – as soon as this order is filled, other orders in the book will start at lower than $39911.2. That means low liquidity.

Let’s see how a low variance in order prices affects the slippage and liquidity.

We have an order book (Sell side) like this:

0.6 BTC – $40,117.7

0.1 BTC – $40,117.4

0.05 BTC – $40,115.5

0.25 BTC – $40,115.7

As in the previous example, they don’t have offers for 1 BTC so the order fills the 4 smaller orders.

The price at which the trader will buy BTC will be:

0.6*40117.7 + 0.1*40117.4 + 0.05*40115.5 + 0.25*40115.7 = $40117.06

40117.7 – 40117.06 = $0.64 slippage

As a result, this order is more cost-effective than the previous one. 

In other words, the best liquidity is when “what you see is what you get” in terms of price, and even if the user is trading large volumes, these volumes don’t affect the prices. That’s why a lot of market participants can benefit from their trading.

Interestingly enough, bigger orders are very unfavorable in markets with lots of smaller traders. If the exchange can’t provide users with the orders of their scale, these users might suffer losses. 

Example

A trader wants to sell 0.5 BTC. The order book includes many small orders with a low price variance. The trader might think it’s good.

0.0007 BTC – $40,109.4

0.05 BTC – $40,109.4

0.005 BTC – $40,109.4

0.01 BTC – $40,109.4

0.0006 BTC – $40,104.6

0.02 BTC – $40,106.2

0.02 BTC – $40,107.5

0.05 BTC – $40,117.4

0.002 BTC – $40,115.7

0.05 BTC – $40,107.7

0.002 BTC – $40,115.5

0.001 BTC – $40,117.7

0.002 BTC – $40,117.4

0.008 BTC – $40,115.5

0.04 BTC – $40,109.4

0.02 BTC – $40,106.2

0.05 BTC – $40,104.6

0.003 BTC – $40,110.7

0.04 BTC – $40,111.4

0.002 BTC – $40,115.7

0.05 BTC – $40,116.6

0.05 BTC – $40,115.5

0.003 BTC – $40,115.7

But if we calculate the average price of BTC for this order like in the above examples (if it fills with all these smaller orders), here’s what we get:

0.5 BTC = $23,970.66

So, the price slippage is…

40,117.7/2 – 23,970.66 = – $3,911.81 

That often happens on DEX (decentralized exchanges) which are not regulated. In turn, regulated exchanges like CEX.IO have multiple sources of liquidity to ensure the most favorable trading conditions for all participants, regardless of the volume.



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