One of the most significant problems facing new exchanges and smaller decentralized exchanges is liquidity. Roughly defined, liquidity refers to the volume of assets within a market, and affects how much trading of an asset can be executed. Small exchanges and startups often suffer liquidity issues simply because inadequate levels of an asset are available to them.
According to Encrybit, 36% of people are concerned about the liquidity an exchange has before signing up to trade on it. To compound the problem, small order books and large bid/ask spreads can slow trading down or bring it to a grinding halt, in some cases, further driving away customers who bring more liquidity.
It’s not all bad news, however. The last year has witnessed some significant developments for exchanges, including the recent Blockchain Exchange Alliance partnership with ONEROOT and the announcement of Blockstream’s Liquid sidechain for the Bitcoin blockchain.
One idea for solving the liquidity issue faced by small exchanges would be to decouple from BTC and ETH pairings and instead offer a greater range of fiat and stablecoin pairings, which would allow people to purchase specific tokens without the need to buy BTC or ETH first. Complexity is a known factor that inhibits crypto adoption. Simplifying the process would bring more liquidity to the market.
Another idea, proposed by the BXA/ONEROOT partnership, is to create a network of exchanges with shared liquidity. To put this into context, BXA is the majority shareholder of Bithumb, South Korea’s largest decentralized exchange. With a shared liquidity pool of that size, small exchanges that join the alliance would benefit from Bithumb’s and each other’s liquidity and order books. ONEROOT has spent the past year developing the technology and tools for the BXA to provide this service.
A big turn off for liquidity providers (i.e., market makers) are the unappealing fees that some exchanges charge. Market makers have been around since trading began and are highly necessary for developing or enhancing liquidity on an exchange. Some exchanges are well aware of their necessity and have created more appealing offers. For instance, ETERBASE has a zero fee market maker program to ensure liquidity when they launch.
The acquisition is also a potential solution. There are over a hundred exchanges, and crypto assets are divided up between them. Therefore, liquidity is divided too. If exchange owners have such big egos that they don’t want to partner up, as in the solution proposed above, then maybe it’s time for good old acquisition to come into play. Instead of competing for liquidity, perhaps some of the better off crypto exchanges could buy it.