A spot market is a place where buyers and sellers come together to exchange cryptocurrency. One of the most notable features of a cryptocurrency spot market is that settlement happens instantly. As soon as an equivalent bid and ask offer is placed, the trade is immediately executed.
More on the bid and ask offers later.
Another noteworthy feature of cryptocurrency exchanges is that they run 24/7. There are no breaks in crypto. Trades can be executed 24 hours a day, 7 days a week, 365 days a year. Not only can you trade, but funds can also be deposited or withdrawn from your exchange account at any time.
Interestingly, most crypto traders still execute trades directly on the exchange. That means a trader will deposit funds into an exchange account, manually place orders to buy or sell an asset, and maintain a trading strategy without the aid of automated software.
Typically, cryptocurrency investors don’t use brokers to manage funds. This can partially be attributed to the fragmented crypto market which makes developing services that interface with exchanges rather difficult. However, as the market evolves in the coming years, brokers and advanced automation software will certainly rise into the spotlight.
A cryptocurrency trading pair consists of two assets. In a single trading pair market, traders have the opportunity to exchange one asset for the other asset and back.
Example: A BTC/USD market would allow you to trade US Dollars for Bitcoin. That means if you had USD and wanted to buy Bitcoin, you could use this market to trade your USD for Bitcoin. On the other end, if there were people who were looking to trade their Bitcoin holdings for USD, they could do that on this trading pair.
Trading pairs between different crypto assets are selected by the exchange. Exchanges don’t allow an arbitrary number of trading pairs on the platform. Instead, each exchange carefully selects the trading pairs that they believe will be popular.
Each trading pair consists of two different assets. This can be seen in the example where we reference the BTC/USD trading pair. The first asset listed is called the base currency, while the second asset is called the quote currency.
To this day, there are still exchanges that get these terminologies incorrect, so let’s break down the meaning of these words in a more simple way.
The base currency is the first asset listed when writing out a trading pair. In the case of BTC/USD, Bitcoin (BTC) is known as the base currency.
Generally speaking, base currencies are typically the less popular asset in a trading pair. When an exchange is deciding what trading pairs they should offer, they may look at a trading pair like BTC and USD and decide that BTC should be the base currency since most people would like to see the price of Bitcoin in terms of USD.
The asset that is used to determine the price of another asset is called the quote currency. That’s because the base currency is quoted in terms of the second currency. As an example, Bitcoin can be quoted at a price of $10,000 for one Bitcoin. Since the price of Bitcoin is shown as 10,000 USD, US Dollars would be the quote currency.
When we are looking at a cryptocurrency market pair, we can quickly determine which is the base currency by either 1) evaluating which currency comes first in the trading pair name (Example: BTC/USD) or 2) seeing which asset is being priced (Example: 1 BTC is $10,000 USD).
Quote currencies (AKA “Counter Currencies”) are the second asset listed when writing the trading pair. In the case of BTC/USD, US Dollars (USD) is known as the quote currency.
In contrast to base currencies, quote currencies are typically the more popular of the assets in a trading pair. We can see this in the example with Bitcoin and US Dollars. US Dollars is a global monetary reserve currency, so it is most certainly a currency that is far more widely used than Bitcoin.
Notice that just because Bitcoin is a base currency for the BTC/USD trading pair, that doesn’t mean there can’t be other trading pairs where BTC is the quote currency.
In fact, many exchanges have BTC as a quote currency for more trading pairs than any other asset. Some examples of trading pairs that most exchanges will list include:
ETH/BTC - An Ethereum to Bitcoin trading pair where ETH is the base currency and BTC is the quote currency.
LTC/BTC - A Litecoin to Bitcoin trading pair where LTC is the base currency and BTC is the quote currency.
XRP/BTC - An XRP to Bitcoin trading pair where XRP is the base currency and BTC is the quote currency.
BCH/BTC - A Bitcoin Cash to Bitcoin trading pair where BCH is the base currency and BTC is the quote currency.
The quote currency will be used to “quote” the price of a base currency.
Example: On the ETH/BTC trading pair, we might see that the price of ETH is 0.04 BTC. Essentially, since we are trading between ETH and BTC on this trading pair, we are evaluating the price of Ethereum in terms of Bitcoin. Notice that we wouldn’t say that the price of Bitcoin is 30 ETH. Since ETH is not the quote currency, we would say it the other way around. Litewise, we could not say the price of ETH is $300 on the ETH/BTC trading pair since we are not trading US Dollars on this trading pair.
An exchange order book is where market participants can view the current offers that are available to buy or sell an asset. In the cryptocurrency market, order books are updated constantly 24 hours a day. That means investors can execute a trade on an order book at any time.
An example of an order book could be for the BTC/USD trading pair. This order book would record the current offers that are available in the market for buying BTC and selling BTC in exchange for USD.
On the order book, the prices will be displayed in terms of the quote currency. Therefore, traders could place offers to buy 0.03BTC for $300, as an example.
Each order book is specific to a single trading pair. While the exchange might have one order book for the BTC/USD trading pair, the exchange will maintain a separate and unique order book for the LTC/USD trading pair, or any other trading pairs.
In fact, the exchange could have multiple order books that involve the same assets. A single exchange could have trading pairs for BTC/USD, LTC/USD, LTC/BTC, LTC/ETH, ETH/BTC, and ETH/USD. Each of these trading pairs would maintain its own order book where trades can be placed between the two specified assets.
The bid prices are orders that are placed to buy the base currency. When evaluating the BTC/USD trading pair, since Bitcoin is the base currency, that means bid prices will be those offers to buy Bitcoin.
In Figure 1, we can see an example order book for the BTC/USD trading pair. The green orders on the bottom are the bid prices.
We can think about it this way. When you are trying to buy something, you would want the lowest price possible. So, you would place lower bid offers than the current market rate. Therefore, we can see how someone buying Bitcoin would want to spend as little US Dollars as possible.
The asking prices are orders that are looking to sell the base currency. Therefore, when someone is trying to sell Bitcoin on the BTC/USD trading pair, the sell offers are referred to as asking prices.
In Figure 1, the red orders on the top are the ask prices.
In contrast to people who are buying an asset, sellers want to receive the highest price possible. Imagine you are the one selling Bitcoin, you would want to get the most money possible for your Bitcoin.
The market spread is directly related to the bid and ask prices on the exchange. Since the market has two sides, that means there must be a gap between these two sides. Essentially, there is a point at which nobody is willing to sell Bitcoin for less than a certain amount and nobody is willing to buy Bitcoin for more than a certain amount.
The gap between these two groups is called the spread.
A market spread can range from being incredibly tight to a wide gap. On some exchanges, it might be typical to only have a market spread of $0.01 on the BTC/USD trading pair. On other exchanges that struggle to get users, the market spread might be $100.00.
A large market spread indicates that the exchange is having issues with providing liquidity. In this case, people who are buying Bitcoin are spending more money than they should and people who are selling Bitcoin are getting less money for their Bitcoin than they should be.
When an exchange has large market spreads, it’s not advisable to trade frequency. Thrashing back and forth by trading on a market with large spreads can cause you to lose a substantial amount of funds. Since each trade is resulting in a bad deal for the trader taking orders.
You can calculate the market spread simply by subtracting the best bid offer from the best asking offer. In Figure 1, we could calculate the spread as $10098.53 - $10093.591 = $4.939.
Cryptocurrency markets can be a confusing concept for many newcomers. Most individuals who will be exposed to cryptocurrency in the next 5 years will never have placed a single trade on any kind of digital exchange. This presents a strong case for services that can interface with exchanges to simplify the onboarding process for new crypto investors.
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When Bitcoin finally emerged from the shadows of the Mt. Gox Bitcoin Exchange hack and subsequent cryptocurrency market crash, interest in the nascent digital asset started rising. Reddit forums, BitcoinTalk, and Twitter started seeing plenty of new faces discussing Bitcoin, Ethereum, and Ripple.