This article aims to provide insights into a fundamental aspect of cryptocurrency trading – the bid and ask. It answers key queries: What are bid and ask? How do bid and ask prices differ from the market price? Why are they crucial? Although these concepts have been around long before Bitcoin came into existence, this article narrows down the discussion to their application in cryptocurrency trading.
- What Is Bid and Ask?
- Difference Between Bid and Ask Price
- Benefits from the Bid-Ask Spread
- Bid and Ask Price Example
- Bid vs Ask vs Market Price
- Final Thoughts
What Is Bid and Ask?
Bids and asks essentially correspond to buyers and sellers, forming the bedrock of any marketplace. Sellers, those who possess cryptocurrency and aim to exchange it for other crypto or fiat currency, place asks.
Conversely, buyers, those looking to purchase cryptocurrency, offer bids.
The highest prices that buyers are willing to pay for crypto are labeled bid prices, whereas the lowest prices at which sellers aim to sell are referred to as ask prices. Consequently, buyers bid, and sellers ask. The trade orders issued by buyers are bids, while those by sellers are asks. These terms are typically expressed in the context of their tradeable price.
Sometimes, asks are also known as offers. A transaction occurs when a buyer agrees to purchase at the best available price (ask), or when a seller consents to sell at the highest bid price.
Bids and asks in the order book (XGo Plus)
Bids and asks emerge from the prices determined by buyers and sellers in the marketplace. When supply outweighs demand, the bid and ask prices tend to decline. Conversely, if demand surpasses supply, bid and ask prices generally rise.
Difference Between Bid and Ask Price
There's a vital term associated with bids and asks: spread. The spread represents the gap between bid and ask prices and is a reliable indicator of market liquidity. A smaller spread implies high liquidity, while a larger one indicates poorer liquidity. This is straightforward to comprehend. Markets with numerous traders offer a greater diversity of choices. Fewer market participants result in fewer asks and bids, widening the spread. Therefore, chances of finding a satisfactory price in such markets are relatively low.
Two kinds of traders exist: market makers and takers. Makers boost the exchange's liquidity by placing limit orders, creating a new offer or bid in the market. Their bid or ask may remain unfilled, meaning their strategy entails certain risks. Nevertheless, makers can also reap benefits from their trading approach. They get to set their own comfortable prices instead of buying/selling at someone else's price. Moreover, as exchanges favor deeper liquidity, they often charge lower trading fees from market makers.
An example of the fee tier for makers and takers on XGo Plus
Takers, on the other hand, fulfill orders already present on the market (in the order book), thereby reducing the exchange's liquidity and widening the spread.
Benefits from the Bid-Ask Spread
Market makers profit from the market spread. While takers purchase at the ask price and sell at the bid price, market makers do the opposite, buying at the bid price and selling at the ask price.
Let's illustrate this with an example. Suppose an exchange trades Bitcoin at $27,000 (bid price) and $30,000 (ask price). The difference between these amounts ($3,000) constitutes the net profit for the market maker. Hence, it's often said that the profits of makers originate from "crossing the spread."
The spread typically increases during volatile periods when sellers hesitate to sell below a certain threshold, and buyers are unwilling to pay a higher price. Liquidity drop, like when numerous traders exit the platform, can also cause the spread to grow.
Bid and Ask Price Example
Going back to our previous example, let's delve deeper. We had a hypothetical exchange offering Bitcoin at a bid price of $27,000 and an ask price of $30,000, making the spread (and the market maker's profit) $3,000.
Spread is also measured in percentage terms. The percentage spread is calculated by dividing the spread amount by the lowest ask price and multiplying it by 100.
In our $27,000/$30,000 example, the spread equates to 10% (3,000 / 30,000 = 0.1; 0.1 x 100 = 10).
Bid vs Ask vs Market Price
Takers trade at the market price. Let's differentiate between the market price and the bid and ask prices. The market price can align with the bid or ask prices, depending on the scenario. Market orders are executed instantly at the best current market price.
Buyers purchase at the best bid price, while sellers sell at the best ask price. In both situations, these prices represent the market prices. The limit sell orders constitute the asks, and the limit buy orders make up the bids. Exchanges automatically set the market prices based on the asks and bids present on the market.
The concepts of bids and asks are pivotal in crypto trading, and understanding the spread is vital for assessing market liquidity. Market makers can reap substantial benefits by placing limit orders, allowing them to trade on their terms and possibly enjoy a fee discount, depending on the exchange's fee policy.
Finally, let's address some common questions about bid/ask dynamics.
Why Is the Bid and Ask Price So Different?
A substantial disparity between the bid and ask price points to low market liquidity. This signifies that the asset pair is traded by a limited number of individuals whose orders display significant price variations. Trading an asset on such a market at your preferred price could prove challenging.
What Happens When Bid Price Is Higher than Ask?
Typically, a bid price exceeding the ask price is uncommon because the interests of buyers and sellers overlap. This means that someone is ready to pay more than what another party wishes to receive for the asset in question. It violates market logic. If this rare situation, known as a "crossed market," does occur, you can buy an asset at the ask price.
What Happens When Bid Price Is Lower than Ask?
This is a normal situation. If you buy at the market price, you will pay the best buy price. If you sell at the market price, you will get the best ask price.
What Does It Mean When the Bid and Ask Are Close Together?
A small bid/ask spread signifies good liquidity in the market. It indicates that there are many traders in the market, enhancing your chances of trading at your preferred price. These markets are conducive to precise trading and generally involve less risk.
How Are the Bid and Ask Prices Determined?
The bid and ask prices emerge from the bids and asks placed by traders on the exchange, at the prices they wish to buy or sell a particular cryptocurrency. Normally, a larger trading volume results in a smaller spread. Prices tend to drop when supply outpaces demand, and rise when supply falls short of demand.