As the financial market, particularly the digital asset landscape continues to expand, players continue to develop innovative solutions to increase their market access. Liquidity aggregation is therefore one of such innovative solutions.
Liquidity is the ease with which an asset (digital, stock, or commodity) can be quickly bought or sold in the market without a significant price change. In more relatable terms, liquidity signifies how quickly and efficiently an asset can be converted into cash or exchanged for another asset. Therefore, the higher the liquidity of an asset, the easier it is to be traded.
Liquidity aggregation is an order optimization strategy. It is the process where multiple sources of liquidity are merged to provide traders with a larger pool of assets. Its operational model involves the integration of liquidity from different sources, like liquidity providers and digital asset exchanges, into a large system or platform that traders can access via a single source.
Liquidity aggregation helps to provide a better-summarized market view for the traders by bringing together order information from various sources. It also enhances order execution by using algorithmic trading and predetermined criteria to select the best liquidity source for each order.
Liquidity aggregation software, also known as a liquidity aggregator, is a tool used to merge and manage liquidity from different sources. One example of such popular software is the Soft-FX Liquidity Aggregator.
Liquidity aggregation has revolutionized the digital asset trading landscape. It greatly benefits the market in several ways, some of them are:
- Price Stability: Liquidity aggregation helps to reduce the discrepancies in the prices of digital asset exchanges and liquidity providers. It helps to average the price ensuring fair pricing across the market.
- Opportunity for smaller traders: Liquidity aggregation technologies provide smaller businesses with the opportunity to access the market. This access might otherwise be out of reach due to trading restrictions such as trading volume requirements on individual exchanges and minimum order size. This inclusion further benefits the market by opening it up to a broader range of participants.
- Deeper order books: Liquidity aggregation leads to deeper and more liquid order books signifying the presence of more buyers and sellers in the market. This in turn reduces the probability of a large huge price distortion from significant orders.
- Improved Efficiency: By integrating liquidity from different sources, liquidity aggregation provides traders with access to a wide range of assets, and thus helps them execute trades quickly. This faster trade execution greatly benefits the market.
- Risk Diversification: With liquidity aggregation, market participants can stretch out their risk. If an exchange lacks liquidity or is experiencing some issues, participants can decide to switch to other sources to reduce their exposure to risk.
The benefits of implementing a liquidity aggregation system are certainly numerous. However, there are some factors that should be up for consideration before the implementation of this platform. They are:
- Counterparty risk
- Regulatory consideration
- The use of in-house, custom, or off-the-shelf software
- The use of a third-party aggregator or integrating LPs directly, amongst others.
Some of the challenges you can encounter after implementing a liquidity aggregation software are:
- Monitoring: Monitoring the system is very key to its optimal performance. Assessing the reliability and the performance of liquidity providers is very important. If not properly done, it can have serious consequences and sabotage the effectiveness of the system.
- Technology requirements and capital outlay: Huge infrastructural resources and rich technology are important for implementing liquidity aggregation systems. These will usually require a huge capital outlay.
Robust liquidity aggregation software helps to build a more accessible, stable, and efficient trading business which is very beneficial to all market participants and fosters innovation in the market.