Building a crypto exchange involves taking care of multiple moving parts to ensure that what you’re offering to the end users builds trust and ensures seamless operations. No one wants to get stuck with assets on an exchange that has liquidity issues. This is why integrating with a reputable liquidity provider can set an exchange up for a long-term success, and not caring enough about liquidity only leads to problems.
It’s important to understand how the concept of liquidity in crypto markets works, as it’s not only relevant for dedicated crypto exchanges. Some solutions require internal trading platforms or utility tokens that have to be bought with stablecoins or fiat currencies.
If it sounds like the idea, you’re trying to build–keep on reading.
What Is Crypto Liquidity?
Before we talk about anything else, let us first explain what liquidity is. In traditional markets, liquidity is the ease of converting assets into cash. However, with cryptocurrencies, we’re also frequently considering liquidity between available trading pairs, such as BTC/USDT, BTC/ETH, and every other.
The amount of liquidity in the market represents the extent of the volatility of the assets. Low liquidity means that the market is highly volatile, leading to abrupt changes in the current price of cryptocurrencies. Providing liquidity into the market will bring stability in the prices, thus easing the trade process. More liquidity actually means there are many market participants, which will translate into faster fulfillment of buy and sell orders. For example, the traditional financial markets and the Forex market has higher economic efficiency because they enable traders to access a highly liquid market.
How liquidity is added to decentralized exchanges?
The Decentralized Finance (DeFi) industry has a different way of functioning than the traditional model of finance. At the core of the DeFi platforms is the decentralized exchange (DEX) that depends on smart contracts-enabled liquidity pools for its operations. But where did the dependency on liquidity pools come from?
Initially, when the DeFi sector was in its nascent stages, there were very few buyers and sellers on these DEXs. People were yet to get accustomed to the smart contracts run exchange interface, and the lack of liquidity was becoming an issue. Liquidity pools emerged as a solution to tackle the liquidity crisis of the DEXs.
Liquidity pools are essentially a reserve full of assets that collect the user-deposited coins for a seamless trading experience. Instead of the traditional order book system, the liquidity pool facilitates the trading of cryptos with minimum slippage. In order to understand the trading process, one also needs to learn about the Automated Market Maker (AMM).
Automated Market Makers
The AMM is the underlying system or protocol on which the DEXs function, enabling permissionless and automatic trading. On these platforms, trading takes place through the liquidity pool, paving the way for decentralization. Rather than directly matching bid-ask prices, the traders trade against the liquidity pool of these market makers.
Let us explain this with an example. Suppose, liquidity providers choose to provide liquidity to a BTC-ETH trading pair on the exchange. They will contribute equal amounts of BTC and ETH into the pool. The Automated market makers platform like Uniswap use the mathematical formula a*b=k for the liquidity pools. While a and b denote the token balance of two respective assets, k always remains constant. Using variations of this market maker protocol formula, the platform maintains equilibrium during trading.
What are the benefits of participating in a liquidity pool?
But why would anybody be interested in contributing liquidity to these liquidity pools? First, the liquidity provider will get a share of the transaction fees when trading is successful on the market-making protocol.
Additionally, the liquidity provider will get a new token called LP tokens when they provide liquidity to the market maker's platform. These tokens are proportionally distributed depending on how much the liquidity providers have contributed to the trading pairs. LP token holders can also participate in yield farming by staking their LP tokens and making passive income.
Where can you find liquidity?
Now that you know the basics, it is time to focus on the multiple platforms that provide the deepest liquidity pools. Crypto exchanges are the greatest source of liquidity in the crypto domain. An exchange with a large number of liquidity providers translates into greater volumes of trade and cash flows. There are different companies that provide a trading platform and contribute to adding liquidity to the crypto domain. Following is the list of some of the top exchanges in the industry.
Genesis is one of the best liquidity providers that provide crypto investors with a marketplace to trade, borrow and lend cryptocurrencies. The regulatory bodies SEC and FINRA regulate all OTC trade on Genesis that takes place across 50 countries. It provides a vast amount of liquidity to users who wish to custody cryptos or use them for working capital. Users can also utilize the liquidity to hedge risks and participate in speculatory investments.
BlockFi is another popular liquidity provider with over $10 billion under management sourced from over 1 million users across the world. Clients can buy/sell their cryptocurrencies as well as earn cryptos from using BlockFi. Users can earn as much as 9.5% APY with their BlockFi Interest Account (BIA). Additionally, they can earn 3.5% in BTC amounting to $100 with their BlockFi Visa Credit Card. Users can also borrow from BlockFi at an extremely low-interest rate of just 4.5%.
LedgerPrime is a cryptocurrency investment firm and one of the leading crypto liquidity providers in the industry. It offers options and derivatives trade with an aim to employ less volatile strategies for crypto investments. The protocol developers established LedgerPrime in 2017 with an exclusive mandate to make digital investing more scientific through data-driven technologies. As a result, the protocol offers sustainable and risk-mitigated returns on diverse kinds of cryptocurrency investments.
Cumberland is a leading liquidity provider in the crypto industry offering a wide range of crypto investing opportunities since 2014. Cumberland is part of the DRW which has vast experience in legacy financial instruments and strategies. Upon successful onboarding, users can participate in almost fee-less exchanging of BTC, ETH and other cryptocurrencies. Cumberland provides electronic exchanging solutions like Marea that offers real-time pricing and API features.
Binance is a top cryptocurrency liquidity provider in the crypto ecosystem with over $2 billion in average trading volume. As a leading crypto exchange, it boasts of executing more than 1 million transactions every second. Binance is compatible on multiple devices and users get to choose to operate the protocol from their Android/iOS phones, desktops, and tablets. Moreover, this liquidity provider has round-the-clock customer support, making it one of the most user-friendly protocols.
Uniswap is an extremely popular crypto liquidity provider in the DeFi ecosystem where users can swap and earn cryptocurrencies. With over 300 plus integrations, Uniswap is an open-source and free-to-access liquidity protocol for the crypto community. Developers and investors can come together in this community-governed marketplace on Ethereum to build a diverse set of DeFi apps. Moreover, the protocol is censorship-resistant with no third-party custody and private order matching.
Coinbase is a leading crypto exchange liquidity provider with over $327 billion in quarterly trading volume and 73 million users across 100 countries. With an easy user interface, Coinbase provides an opportunity to buy and sell cryptocurrencies with just a few clicks. Users can link their bank accounts as well and seamlessly swap fiat money with cryptocurrencies. Coinbase offers highly secure offline storage facilities for all its cryptos along with insurance protection for its investments. FDIC provides insurance of up to $250,000 with USDC investments coming under its ambit. Users can manage their portfolios and participate in recurring buy options from their Android/iOS phones.
Huobi is one of the topmost liquidity providers in the global blockchain community with multiple user-friendly features. For a start, users can buy cryptos with their Visa, MasterCard, other Credit cards, PayPal, or bank transfers without any additional fees. Additionally, Huobi stores all user funds in multi-signature cold wallets with robust round-the-clock security. There is also a specially dedicated Security Reserve Fund with 20,000 BTC. Huobi offers multiple investment opportunities for its users ranging from derivatives, futures, OTC trading as well as staking and lending. Users can access this liquidity provider from their smartphones to deposit and withdraw their money.
When a crypto exchange is only a part of the business
The market for crypto exchanges is quite saturated already, and the biggest, well-established brands such as Coinbase or Binance are taking advantage of their positions. However, other projects might often want to add exchange as an additional feature to their offering.
For example, we have built such an exchange for Lendingblock, a lending and borrowing platform. An LND token (ERC-20) has been added as a utility and for platform governance. At certain LND balance tiers, users get cheaper borrowing rates or higher returns on their deposits. At any time, they can trade the USDT/LND pair–and they can do so on the purpose-built exchange. It still had to operate like other exchanges, with a matching engine, limit and market order mechanisms, and ensured liquidity. You can read more on that in our case study.
If you’re looking to release an exchange for your token, build a new trading experience based on a white label exchange or integrate with one to provide liquidity – don’t hesitate to tell us more about your project! We’re able to help you at any stage.