How is the Unit Price or Market Value of a Cryptocurrency Determined on a Cryptocurrency Exchange?

In the dynamic world of cryptocurrency trading, understanding the “Ask-Bid Spread” (Supply and Demand Ratio) is crucial for both beginners and professional traders. The “Supply and Demand Ratio” is a fundamental concept that represents how prices are determined in the market.

This article will explain the mechanics behind the “Supply and Demand Ratio”, how prices are determined through trading, and the key components of this process.

What is the “Supply and Demand Ratio”?

The “Supply and Demand Ratio” is the difference between the Ask Price (the lowest price a seller is willing to accept) and the Offer Price (the highest price a buyer is willing to pay) for a cryptocurrency on a crypto exchange, such as Mercury Iconex.

- Ask Price: This is the price at which sellers are willing to sell their cryptocurrency. It is also known as the “sell” price.
- Supply Price: This is the price at which buyers are willing to buy the cryptocurrency. This is also known as the “buy” price.

Example:
Let’s say you are looking at the order book for Bitcoin (BTC) on Mercury Iconex:
- Ask Price: $60,100 (This is the lowest price a seller offers to sell BTC).
- Offer Price: $60,000 (This is the highest price a buyer is willing to pay for BTC).

The "Supply and Demand Ratio" in this case is $100 ($60,100 - $60,000).

Why is the "Supply and Demand Ratio" important?

The "Supply and Demand Ratio" is important because it represents the transaction costs for traders. A smaller Ratio means the market is more liquid, with many buyers and sellers, making it easier to trade without significantly affecting the price. Conversely, a larger Ratio indicates a less liquid market, where trades can have a longer wait time and can have a greater impact on the price.

- Small Ratio: Indicates a highly liquid market with a lot of trading activity. It is easier to buy and sell without delays and affecting the market price.
- Large Ratio: Indicates lower liquidity, meaning fewer participants are trading. This can lead to higher costs when executing trades.

How are prices determined on a cryptocurrency exchange?

Prices on a cryptocurrency exchange are determined by the interaction between buyers and sellers through a process called market transactions. Below is a step-by-step explanation of how this works:

a. The order book:
- The order book is a list or column of buy and sell orders for a particular cryptocurrency. It shows the total amount of cryptocurrency that traders are willing to buy or sell on the market, at different prices.
- Buy orders: These are displayed with the highest bid price at the top of the list. These are offers from buyers who want to buy cryptocurrency. (Green price column)
- Sell orders: These are displayed with the lowest ask price at the top of the list. These are offers from sellers who want to sell cryptocurrency. (Red price column)

b. Market orders vs. Limit orders:
- Limit orders:** A trader sets a specific price at which he wants to buy or sell. The order is only executed if the market reaches that price.
- Market orders:** A trader wants to buy or sell immediately at the best available current market price. Market orders often reduce liquidity from the order book.

c. Matching engine:
- The crypto exchange's matching engine and technology automatically matches buy orders with sell orders. If a buyer’s Offer price is equal to or higher than a seller’s Ask price, a transaction occurs and the transaction is executed.
- For example, if a buyer places a market order to buy 1 BTC, the matching engine will find the lowest available Ask price in the order book and execute the transaction.

d. Determination of the Market Price:
The unit price or market value of a cryptocurrency is essentially the price at which the most recent transaction took place. This price is constantly updated as new transactions are executed.

e. Impact of Large Orders:
- Large buy or sell orders can significantly impact the price, especially in markets with little liquidity. For example, a large buy order can push the price upwards, while a large sell order can push the price downwards.

Components involved in market functioning

Several important and crucial components work together in sync to facilitate trading and determine prices on a cryptocurrency exchange:

a. Market makers:
Market makers are participants who provide liquidity by placing both buy and sell orders in the market. They take advantage of the "Demand and Supply Ratio" between the buy and sell prices. Their activity helps keep the market liquid and the Ratio small.

b. Liquidity providers:
Liquidity providers, often institutional players or automated trading systems, ensure sufficient volume on both sides of the order book. They reduce volatility and keep the markets efficient.

c. Takers:
Takers are traders who place market orders that match existing orders in the order book. They "take" liquidity from the market and pay the Ratio.

d. Exchange Infrastructure:
The crypto exchange’s Blockchain technology, including the Matching Engine, Order Book, and Trading Interface, facilitates the entire trading process. A robust infrastructure ensures that trades are executed quickly and accurately.

Real-world Example: The “Supply and Demand Ratio” in Action

Suppose a new token is listed or launched on Mercury Iconex. At launch, there may be fewer sellers than buyers, making the asking price relatively high. If there is high demand, buyers may be willing to pay more for that new token, leading to a narrower spread and a rising market price. Over time, as more sellers enter the market, the spread may widen or narrow depending on the balance between supply and demand.

For beginners, understanding the “Supply and Demand Ratio” is essential to making informed trading decisions. The Ratio directly impacts the cost of trading and can provide insight into the liquidity and health of the market. For more experienced traders, the Ratio can be a tool for developing trading strategies, such as arbitrage or market-making, to earn income.

Whether you are new to cryptocurrency trading or a seasoned professional, understanding the mechanics behind the “Supply and Demand Ratio” and how prices are determined on a cryptocurrency exchange will give you a better understanding of market dynamics and help you navigate the ever-changing world of digital assets with greater confidence.

Updated on: 14/12/2024