If you’ve ever had any experience trading cryptocurrency, stocks, or any other asset through an exchange, then you’ve probably come across a price spread. For many, this is a pretty insignificant term that doesn’t hold too much weight when it comes to how it impacts their overall portfolio. However, it turns out that price spreads can actually have a pretty significant impact on how the market functions as a whole, resulting from basic supply and demand laws of economics. Let’s go over what spreads are, how they function, and why they’re so significant for the market as a whole.

This is not financial investment advice.

This article will touch upon key aspects of price spreads within the cryptocurrency market.

In this article

What Is a Spread?

Price spreads are commonly seen on exchanges and other websites which indicate the value that certain coins are trading at. So, what are they then? Well, price spreads are the difference between the highest buy order and lowest sell order on a certain exchange. There is a point of equilibrium, where buyers’ and sellers’ orders meet, and always a gap, which fluctuates and moves as trade orders on the opposite sides get resolved, causing the overall price to go up or down.

Just remember that every trade happens when you’re buying from someone or selling to someone. As such, sellers want to sell as high as possible and buyers want their price to be as low as possible. This forms the gap between their expectations, which is called spread. That’s why at any given moment of time the price you can buy at (which means someone is selling to you at that price) is higher than the price you can immediately sell at (which means there is a buyer on the opposite side, willing to buy at that price).

If there is ever an overlap between the two sides of the gap, the overlapped trade order is immediately resolved and voila, our price gap appears again! You’ll see this gap — referred to as the “spread” — on any exchange in the world. The lower price is known as the “bid price” and the higher one is the “ask price.” The concept of having a single price emerging from news feeds, which most of the people are familiar with, is actually an average of the spreads given as a single value, just for convenience.

Price spreads are the difference between the highest buy order and lowest sell order on a certain exchange. The value of a single cryptocurrency is actually just an average of all the spreads across its exchanges around the world.

How Do Spreads Affect the Market?

As it turns out, price spreads actually have a significant impact on the rest of the market in terms of price fluctuations and liquidity. The more liquid a market is, the lower its average price typically is. The liquidity of a market refers to the degree at which something can be bought or sold on that market quickly without impacting the item’s price. Thus, if there is a low degree of liquidity and somebody wants to buy a coin, their purchase will likely raise its price since the price spread would be bigger in an non-liquid market. The closer the price spread, the less that the price is impacted during the buys/sells.

Additionally, spreads play a role in leading to increased price volatility. For example, if the price of a cryptocurrency on one exchange is higher compared to virtually all other exchanges, people will start to buy it from the lower-priced platforms. These coins are then transferred to the platform where the price is higher and sold for a profit. This will inevitably result in the latter exchange receiving a large influx of new coins being dumped on the market, ultimately driving the price down again.

Spreads can determine the liquidity and price volatility of a coin in the market. The lower the price spread is across all exchanges, the less price volatility there is.

Why Do They Matter?

Investors can actually use spreads to their advantage by exploring different avenues to increase the value of their assets. In the world of cryptocurrency — and pretty much all of finance — investors seek to gain the most bang for their buck. More specifically, they will buy assets and currencies which they are interested in at the lowest prices possible and compare prices across different platforms and exchanges to score the best deal. Price spread opens up a lot of arbitrage opportunities for experienced traders.

As is the case with any opportunity to increase your overall financial gain, potential issues also arise along the way. A price spread can be taken advantage of to buy assets and currencies at a lower price and sell them on a different platform for a profit. This is known as arbitrage trading and has been taken advantage of by many experienced traders who are aware of how to manipulate the price spread for their own gain. Of course, this is assuming that one can transfer said funds in a timely manner before the prices have caught up between these specific platforms or exchanges.

Spreads are actually used as a tool by many experienced traders to involve themselves in arbitrage trading, which is buying an asset on one exchange at a lower price and selling it on another exchange at a higher price.

Conclusion

Before you quickly denounce price spreads as being insignificant pieces of information on an exchange, take a second to assess all the uses for it. Outside of just giving you a better understanding of what an asset is trading for, price spreads can give you a chance to explore arbitrage trading among different exchanges. Of course, this all relies on your ability to quickly transfer funds to the correct exchange before the price spread catches up. Irrespective of how you view arbitrage trading, understand that spreads are actually extremely valuable when it comes to how they affect the cryptocurrency market and why traders makes the decisions they do. As always, happy investing!