If you’re new to cryptocurrency trading, the various terms used within the trading ecosystem can quickly become complicated. Market spread, also referred to as bid-ask spread, is a key factor that can impact your long-term trading costs and affect your gains and losses. Here’s everything you need to know about market spread.
When trading cryptocurrency via the order book on a cryptocurrency exchange, you’re interacting with other market participants that seek to either buy or sell their assets. Market participants place orders to buy and sell cryptocurrencies, which remain open until they are filled.
An individual may, for example, choose to place an open order to buy Bitcoin at $15,000. This order will remain open until another individual place an order to sell Bitcoin at the same price, at which point the order will be filled.
Sellers and buyers using an order book to trade assets may have different perspectives on how much an asset they want to sell or buy an asset for. The difference between these perspectives affects market spread.
What is crypto market spread?
Market spread is the difference between the highest bid offer — the lowest price at which individuals are willing to sell an asset, and the lowest ask offer — the highest price at which individuals are willing to buy an asset within an order book.
In simple terms, the market spread is the difference between the price one person wants to purchase an asset and the price another person wants to sell it for.
Market spread can be presented in simple terms as an interaction between two users on a cryptocurrency exchange. Person A may want to buy Bitcoin for $15,000, while Person B may want to sell Bitcoin for $20,000. The difference between the bid of $15,000 and the ask of $20,000 is the spread.
Cryptocurrency exchanges, however, aren’t used by just two people at a time. The order book of any cryptocurrency exchange consists of thousands of different orders, with as many different bid or ask prices.
How is market spread calculated?
Calculating crypto market spread is a relatively straightforward process. In order to determine the market spread of an asset such as Bitcoin, the highest bid price within the order book is subtracted from the lowest ask price.
Calculating Bitcoin market spread in an order book in which the highest bid price for Bitcoin is $1000.00 and the lowest ask price is $1000.01, for example, is performed as follows:
$1000.01 – $1000 = $0.01
It’s also possible to calculate the percent spread of an asset by taking the spread and dividing it by the lowest ask price, then multiplying it by 100, as follows:
$0.01 (spread) / $1000.01 x 100 = 0.00099%
The spread within the above example is, therefore, $0.01 — but what insights can this information provide?
Why is market spread important when buying and selling crypto?
Market spread can be considered as a de facto measure of the supply and demand of any given asset. In simple terms, bid prices represent demand, while ask prices represent supply. An increase in spread, therefore, represents changes in supply and demand or market liquidity.
Market spread is important when calculating the cost of trades versus the profit generated from a trade. Under some market conditions, market spreads may render some trades unprofitable due to high spreads.
For example, let’s take a look at a Bitcoin trade with a significant market spread. Within this example, the lowest ask price for Bitcoin within an order book is $10,000, while the highest bid offer is $9,500.
The market spread within this example is $500. The percentage spread, calculated using the formula outlined earlier, is therefore 5%.
A trader that buys Bitcoin at the $10,000 lowest ask price is unable to sell the purchased Bitcoin at a profit until the highest bid price increases significantly over $10,000 if the spread remains the same.
If the highest bid price of Bitcoin reaches $10,200 with a percentage spread of 5%, the lowest ask price is, therefore, $9690. The trader that purchased Bitcoin at $10,000 would therefore incur a $310 loss should they sell their Bitcoin, even though the highest bid price of Bitcoin is $200 higher than when the Bitcoin was purchased.
Cryptocurrency traders should pay careful attention to market spread, as it represents an often-overlooked cost incurred when trading and can provide accurate insight into market liquidity. The impact of market spread can be minimized by utilizing limit orders or assessing spread percentages.