When you buy and sell assets on a crypto exchange, the market prices are directly related to supply and demand. Apart from the price, other important factors to consider are trading volume, market liquidity, and order types. Depending on the market conditions and the order types you use, you won't always get the price you want for a trade.
There is a constant negotiation between buyers and sellers that creates a spread between the two sides (bid-ask spread). But how to profit from bid ask spread? That’s what we’ll look into in this piece.
What is Bid-Ask Spread?
The bid-ask spread is the difference between the highest bid price and the lowest ask price of an order book. In traditional markets, the spread is often created by the market makers or broker liquidity providers. In crypto markets, the spread is a result of the difference between limit orders from buyers and sellers.
If you want to make an instant market price purchase, you need to accept the lowest ask price from a seller. If you'd like to make an instant sale, you'll take the highest bid price from a buyer. More liquid assets (like forex) have a narrower bid-ask spread, meaning buyers and sellers can execute their orders without causing significant changes in an asset's price. This is due to a large volume of orders in the order book. A wider bid-ask spread will have more substantial price fluctuations when closing large volume orders.
How to Profit from Bid Ask Spread?
The concept of liquidity is essential to financial markets. If you try to trade on low-liquidity markets, you might find yourself waiting for hours or even days until another trader matches your order.
Creating liquidity is important, but not all markets have enough liquidity from individual traders alone. In traditional markets, for example, brokers and market makers provide liquidity in return for arbitrage profits.
A market maker can take advantage of a bid-ask spread simply by buying and selling an asset simultaneously. By selling at the higher ask price and buying at the lower bid price over and over, market makers can take the spread as arbitrage profit. Even a small spread can provide significant profits if traded in a large quantity all day. Assets in high demand have smaller spreads as market makers compete and narrow the spread.
For example, a market maker may simultaneously offer to purchase BNB for $350 per coin and sell BNB for $351, creating a $1 spread. Anyone who wants to trade instantly in the market will have to meet their positions. The spread is now pure arbitrage profit for the market maker who sells what they buy and buys what they sell.
Bid-Ask Spread Percentage
To compare the bid-ask spread of different cryptocurrencies or assets, we must evaluate it in percentage terms. The calculation is simple:
(Ask Price - Bid Price) / Ask Price x 100 = Bid-Ask Spread Percentage
Let's take BIFI as an example. At the time of writing, BIFI had an ask price of $907 and a bid price of $901. This difference gives us a bid-ask spread of $6. $6 divided by $907, then multiplied by 100, gives us a final bid-ask spread percentage of roughly 0.66%.
Now suppose that Bitcoin has a bid-ask spread of $3. While it’s half of what we saw with BIFI, when we compare them in percentage terms, Bitcoin’s bid-ask spread is only 0.0083%. BIFI also has a significantly lower trading volume, which supports our theory that less liquid assets tend to have larger bid-ask spreads.
Bitcoin's narrower spread allows us to draw some conclusions. An asset with a smaller bid-ask spread percentage is likely to be much more liquid. If you want to execute large market orders, there is usually less risk of having to pay a price you didn't expect.
Closing Thoughts
When you trade cryptocurrency, don’t forget that a bid-ask spread or slippage can change the final price of your trades. You can’t always avoid them, but it’s worth factoring into your decisions. For smaller trades, this can be minimal but remember that with large volume orders, the average price per unit might be higher than expected. And if you’re planning to make money from the spread, this article should provide you with a base understanding on how to profit from bid ask spread.
