The bid-ask spread in asset trading denotes the gap between the lowest selling price and the highest buying price, reflecting market liquidity and trading costs, and embodies the bargaining room between buyers and sellers.
The bid-ask spread, in essence, represents the discrepancy between the cheapest asking price from sellers (asks) and the highest bidding price from buyers (bids). Envision this as the haggling arena where both parties negotiate a transaction.
This gap materializes through two common mechanisms. Firstly, it may be intentionally engineered by brokers or trading platforms as a revenue stream for their services rendered, akin to merchants at a marketplace reserved room for negotiation to secure profits on each transaction. Secondly, the spread organically arises in open markets due to the diversity of limit orders placed by numerous traders, naturally creating a price range between buy and sell orders.
In conventional financial markets, the bid-ask spread is a standard means for trading platforms to monetize. While many brokers and platforms tout commission-free trading, they often profit by manipulating these spreads. In effect, the platform acts as a market maker, buying low and selling high, pocketing the difference. It’s akin to an intermediary profiting off the spread between purchase and resale.
However, the realm of cryptocurrencies diverges slightly. Most transactions occur on cryptocurrency exchanges where buyers and sellers directly post orders onto an order book. Exchanges primarily derive revenue from transaction fees rather than the bid-ask spread, fostering a more transparent process where users can intuitively observe market dynamics.
It's noteworthy that in highly active and liquid markets, the bid-ask spread tends to be narrower. This stems from fierce competition between buyers and sellers, driving prices swiftly towards equilibrium and thereby narrowing the spread. Conversely, in less liquid markets with lower trading volumes, wider spreads are commonplace. Think of a narrow alley versus a broad avenue – in the former, limited space prompts individuals to accept larger discrepancies, whereas on the bustling avenue, intense price competition naturally narrows the gaps.
