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Jul 27, 2022

Bid-Ask Spread

Bid-ask spread represents the difference between the bid — the price buyers are willing to pay — and the ask, which is the price sellers are willing to accept to trade a financial instrument.

What Is the Bid-Ask Spread?

In a typical crypto market, two main players determine the price of an asset: The buyer and the seller.

The bid price is the highest price that the investor is willing to pay for a security, whereas the ask price is the lowest price for which the seller is willing to sell it. The difference between the bid price and the ask price is known as the bid-ask spread.

Example:

Crypto Bid Price = $172.80

Crypto Ask Price = $173.00

Bid-Ask Spread = $173.00 − $172.80 = $0.20

In a traditional crypto exchange, the ask price is usually displayed above the bid price. 

To understand the bid-ask spread from the perspective of a real-world scenario, let's take an example of the BTC/USDT pair. Suppose that you want to buy BTC, which shows an ask price of $21,250.50 and a bid price of $21,249.00. In this case, you’ll pay $21,250.50 to buy BTC, because the ask price is the maximum amount for which sellers are willing to sell Bitcoin.

On the other hand, if you’re the seller who wants to sell BTC, then you would sell it at the bid price — i.e., $21,249.00. This is the maximum price that a buyer is willing to pay you.

If you're still confused, it's always better to think of the ask price first: It’s the price for which sellers are willing to sell their crypto. On a crypto trading platform, it's often displayed above the bid price because it's always greater than the bid price. The difference between the ask price (the greater amount) and the bid price (the smaller amount) is the bid-ask spread.

How Does the Bid-Ask Spread Work?

A bid-ask spread not only helps determine the existing price of an asset, but it also offers an opportunity for market makers to earn profits from the spread. In a traditional market, market makers are usually the broker and the trading platform.

Since market makers are the ones who provide liquidity to the market, they control the bid-ask spread. The spread allows them to make a profit from trading activities.

Not everyone uses the market maker model. Due to the decentralized nature of DeFi, crypto exchanges don’t rely on it. Since market participants place orders directly into the order book of a crypto platform, the market price is determined by supply and demand. In this case, the crypto exchange charges a trading fee for each transaction so it can earn revenue.

Importance of Bid-Ask Spread

If you're just beginning to trade financial instruments, keep an eye on the bid-ask spread. A tight bid-ask spread usually indicates a liquid cryptocurrency, because there are lots of buyers and sellers in the market. Usually, most well-known crypto pairs have tight spreads, in which case the bid-ask spread doesn't matter.

In contrast, lesser-known and newer cryptocurrencies may have large bid-ask spreads, which means that you may not get the price you're looking for. For instance, if the ask price of a crypto is $1.60 and the bid price is $1.40, the bid-ask spread is $0.20 — or 12.5% of the ask price. In this scenario, only buy the crypto if you want to hold on to it over the long run.

If the bid-ask spread is higher than 1%, it's better to trade with a limit order so you can get your desired price without incurring a significant loss. Another alternative is to look for a different trading exchange that may offer a more reasonable spread on the particular crypto pair.