How To Provide Liquidity To Cryptocurrency Exchange?

The currency rates change frequently, and hence the dealers in this field have to be more alert. Among the currency market, one can also go for virtual currency as there are many currencies present in the finance market. The cryptocurrencies are also much in demand these days. Various trading exchanges are also present to facilitate the trading of various currencies. The exchanges also have started providing liquidity that can accelerate trading across the exchanges. The traders prefer to go for this option for a long term and short term trading.

Cryptocurrency Exchange

Cryptocurrency exchange depends on liquidity, just like any other financial market. When traders sense that there is a lack of liquidity, they tend to move to other avenues. Liquidity crunch emerges when traders are not able to buy and sell assets in a quick time at a reasonable price. On the other hand, when the liquidity is good, it attracts more traders in the long run.

The effect of a single transaction on the market and the price of the asset decreases a lot when there is enough liquidity in the market. Imagine a situation when there is no liquidity, a single large order can push or pull the price, and this is not a good sign for the market in the long run. However, when there is enough liquidity, such single transactions do not affect the price in a major way, and the market will be able to absorb all these fluctuations without any hassles.

You will be surprised to know that even big exchanges like the New York Stock Exchange partner with in-house liquidity providers. Such is the importance of liquidity in the financial market. Such liquidity providers are market makers, and they play a major role in defining the market value of the asset for a short duration. Whenever the buy and sell orders are sent to the markets, such measures are taken to provide liquidity to the participants.

However, when it comes to the crypto industry, it is still new and has some issues with liquidity. This is not the case with all the crypto exchanges, and only a few of them are facing a liquidity crunch. On the other hand, some big exchanges are managing to provide good liquidity for the traders due to increased participation of intraday and long term traders. Crypto finance is helping in this regard, and venue operators in the crypto industry are able to provide liquidity using such measures.

In this regard, third party market makers are playing an important role in enhancing liquidity. Apart from that, cross-exchange market-making, along with liquidity mining, will help to resolve the liquidity issues in the crypto market. Multiple solutions can be tried with different operational capacity, and this will help the exchanges to overcome problems with liquidity.

Understanding third party market makers

Just like the in-house market makers of big financial markets, even cryptocurrency markets have market maker agreements, and this can resolve liquidity crises in the long run. In most cases, an outside hedge fund can act as a market maker, and they will be able to provide liquidity to traders in the crypto exchanges. Such hedge funds often trade the same commodity in multiple venues, and this helps them to manage the liquidity by executing trades in other venues to balance the liquidity provided in one venue.

When it comes to hedge funds, they also get to benefit a lot as they can capitalize on the price difference between two venues and make marginal profits. As they trade in large quantities, even a small profit margin will result in huge gains for them regularly. They also maintain the required inventory levels at all times so that they can easily provide good opportunities for traders to enter and exit trades without any hassles. The market makers and trading venues often agree on certain profit levels that the makers can expect on a monthly basis. In the event the makers are not able to profit that much in a given month, the venue will compensate them for the difference, and this will keep the partnership active for next month.

Cross exchange market making

In this case, the venue operators themselves provide liquidity without depending on third party market makers. In this way, they engage in cross-exchange transactions to provide liquidity to traders. This can reduce their losses without taking too much risk.

The venue operators act as market makers and can reduce their expenses by a huge margin. However, they will not have access to credit like the market makers and have to depend on their own inventory to offer the guarantee to other exchanges. Even though this is a small drawback, it can also bring them decent profits in the long run. In this way, they get to keep the traders happy and also make some additional money by acting as market makers.

Understanding liquidity mining

This is a new concept when compared to the other options discussed in this article. In the crypto industry, most things depend on community participation, and blockchain protocols often reward individuals for running nodes or staking coins. When these things are structured properly, they can also help to resolve liquidity crises in the crypto industry.

In this case, the venue operators distribute open-source software to any participant who wants to act as a market maker, and they can download it. Their crypto wallets will be connected with the help of which the trades on the exchange can be done automatically.. However, the liquidity miners can set some parameters for the execution of market-making trades, and this means that they have some control over the system. The pool of rewards is generated by the algorithm, and it will be distributed among all the miners who participate in the mining.

In this way, each exchange can adopt one of the above measures or a combination of some measures to increase liquidity in the cryptocurrency market. This can also boost investor confidence and bring in more players in the long run.