What is Liquidity Aggregation and How it Works?

Any financial market is a complex high-tech system of interconnected components, each of which determines the stability and efficiency of the process of trading financial assets. Based on the principle of interdependence of supply and demand levels, an essential electronic trading component is sufficient liquidity, which is aggregated by different market players including liquidity providers.

In this article, you will learn about liquidity aggregation, its benefits, and how it is delivered to the financial market.

Liquidity aggregation – the process of combining offers to buy/sell an asset from distinct places and directing them to executors. The purpose of aggregation is to enable market participants (traders and investors) to buy trading assets at close to market prices. Today, regardless of the financial market, the aggregation, and delivery of liquidity occur in two ways: either with the help of specialized software developed to meet the specifics of a particular capital market (Forex, crypto, etc.) or with the help of Prime. Both methods have their own peculiarities of work, pluses, and minuses, but simultaneously provide an effective liquidity supply process.

The Prime of Prime method is a time-tested, long-established liquidity aggregation scheme for financial markets that involves working directly with liquidity providers. It implies the use of services of technology companies, major brokers and international banks that provide greater market depth either by collecting liquidity from several sources or independently as clients of Tier 1 liquidity providers. Such liquidity providers can work through liquidity pools aggregating their liquidity from various sources, thereby ensuring flawless order execution speed both for trading pairs and digital assets.

Despite the general principles of liquidity delivery, the liquidity accumulation process may differ to some extent from market to market. Suppose a liquidity provider works with brokers in highly volatile markets using a direct market access delivery system. In that case, efficient trading is ensured through mechanisms to quickly redistribute liquidity from one cryptocurrency asset to another to avoid price gaps and slippage due to price swings. The FX liquidity aggregation process is similar to the cryptocurrency market. Still, it often takes place in the plane of special software, through which the stability of currency pairs is maintained. In contrast, in terms of crypto trading, users can aggregate liquidity through the staking of a digital asset.

Aggregation of liquidity from multiple sources allows not only increases the efficiency of the trading process but also contributes to the development of the broker’s ecosystem, providing access to cooperation with many reliable financial companies providing liquidity. At the same time, aggregation provides essential advantages in independence from the financial market.

Due to the aggregation of liquidity from different sources, it is possible to significantly expand the list of assets for trading, regardless of the financial market. Having a high level of liquidity, it becomes possible to trade both known and liquid assets and less liquid ones, because in case of a situation involving sharp price change of low-liquid instruments, the liquidity from the pool will be used to maintain the stability of quotations, to exclude the probability of collapse. This applies to any of the existing capital markets and to any asset class.

The aggregation of liquidity directly affects the speed of execution of market orders in the financial markets. If trading a specific asset, regardless of its liquidity level, allows you to freely buy/sell the necessary amount, we can say that, in this case, a single source of liquidity is used, which allows you to execute orders no higher than the average execution speed of the market. If there are several sources, the speed of execution increases significantly, making it possible to use high-speed trading strategies (like scalping) without financial losses on the spread.

Aggregating liquidity from various sources helps to provide ideal conditions for buying assets at the best market prices by enabling you to execute orders with the minimum spread, which results in the best buy/sell price with a number of other supporting factors that determine the equilibrium between supply and demand and ensure overall market stability. In general terms, increased liquidity will always be the key to the best trading experience by reducing (or eliminating) the spread of any given financial instrument.

Liquidity aggregation is a closed and, at the same time, a continuous process ensuring the smooth operation of all systems responsible for a stable trading process. As a rule, companies and brokers receiving liquidity from large liquidity providers simultaneously form liquidity pools through their applications, increasing trade turnovers. In turn, clients connected to these companies act as both liquidity consumers and suppliers. Let us consider the main sources of liquidity formation in the market. 

The main source of liquidity in trading any financial instrument on any market are the incoming buy/sell orders from ordinary private traders and investors. By placing market and pending orders, they trigger the process of formation of liquidity, which can be used to replenish liquidity in low-liquid assets. High liquidity of some or other instruments is usually provided due to high interest (demand) for this or that trading instrument, but for stable work it is also necessary to have a high level of supply from sellers. This way of aggregation excludes such phenomenon as counterparty risk, as it does not involve the conditions, under which traders cannot meet their obligations.

The term institutional investor is commonly used to describe large and often international companies or their associations that accumulate money (capital) of smaller participants for the purpose of making profits by investing on financial markets. Their main difference is the size of investment capital and volume of transactions, which exceed the capabilities of practically all other participants of trades. As a result, they get certain preferences in trading operations, one of which is the aggregation of liquidity into pools, where it is used to maintain a trading volume of financial assets. In most cases, large transnational financial conglomerates in the form of banks constitute such class of investors.

The exchangers are specialized services for exchanging one currency for another with the possible retention of a specific commission. Professional exchangers allow exchanging of a large number of different trade instruments, including fiat and cryptocurrencies, using different payment methods and systems. Due to large volumes of funds passing through them, such services have ample liquidity, which can also be aggregated within one forex broker or crypto exchange.

While liquidity refers to how quickly and at what price an asset can be sold, it also serves as a general indicator of market trading stability. Liquidity aggregation helps accumulate cash from a variety of sources and directs it to poorly liquid assets, keeping supply and demand in balance.