The single most important feature of any trading exchange is liquidity. Without liquidity, operating a successful exchange becomes unviable. This is particularly true of cryptocurrency exchanges with volatile markets whose traders want to cash out (liquidate) their positions quickly.
When new tokens appear on crypto exchanges, they are often thinly traded, which results in difficulties in supply and demand, therefore diminishing liquidity.
I spoke to Digitex Futures CEO Adam Todd to find out why liquidity is so important — and how his upcoming commission-free futures exchange plans to ensure liquidity for traders.
Futures Trading: A Snapshot
Futures trading has existed since ancient times, going all the way back to around 1750 BC. The way in which people recorded trades (on clay tablets) looked a little different from today, but the concept is still the same. A futures contract is an agreement between two parties to buy or sell an asset at a future price and date, specified in the contract.
Going back to our ancestors, you could think of futures contracts as a kind of Mesopotamian “IOU.”
Today, futures trading allows traders to navigate the choppy waters of particularly volatile markets — which is why futures trading lends itself so well to crypto.
“Futures is basically a concept to address volatility,” Todd explains.
“Think about the oil market. The price per barrel can fluctuate greatly in any given month. Last year, the price bottomed out around $40 per barrel and this year it’s soared to around $70.
But for companies that need large quantities of oil often, such as airlines, to offset volatility, they enter into futures agreements at a set price.”
He continues, “This provides the issuer the peace of mind of receiving his absolute minimum trading price, even if market value falls, and it also protects the buyer against price escalation.
Clearly, there are winners and losers in any futures exchange. If you entered an agreement to sell 10,000 barrels at a fixed price of $50 and the actual market price at the time the contract expires is $70, the airline comes out on top.
But it can just as easily go the other way.
Think about futures in crypto. Who would have predicted that Bitcoin would have hit an all-time high of high of almost $20,000 in December 2017 and then fall back down to a quarter of that this year?
Maybe a futures trader. And if he had, he’d be making a lot of money right now even in a bear market.”
Why Is Liquidity So Important to Exchanges?
The more traders you have, the more volume, the more volume, the more liquidity.
If an exchange becomes illiquid for whatever reason (a lack of trust, trader confidence, a security breach), it usually goes out of business pretty fast.
That’s why all exchanges must work to ensure there is ample liquidity at any given time. Especially in futures trading where there is potential for extremely high profits.
While the term “futures” automatically makes us think of faraway dates, some traders use short-term, aggressive trading strategies to make a profit.
This method of trading, known as “scalping” is the model that Todd (himself a former pit trader) has always found worked best for him.
Futures traders can actually earn a profitable living going for short upticks in the price. However, this profit is often wiped away due to commission fees. Todd explains:
“When I was trading back in the 90s, I was taking quick, single tick profits and losses so that I could trade quickly and profitably. But the huge trading commission fees had a massive negative impact on my PnL. Some days, they turned profitable days into losing days and made my scalping strategy ineffective.
I daydreamed about zero commission-fees back then, and back then, it really only was something to dream about.”
Zero Commission Fees Will Increase Liquidity
According to Todd. the biggest winners from commission-free trading will be traders who use aggressive trading strategies with a single-tick profit target, like himself.
Although traders of all stripes will appreciate not having to hand over a slice of their profits to a centralized exchange.
“If traders know that they can use scalping strategies and not get hit by crippling commission fees, they will naturally flock to the Digitex exchange,” Todd states with confidence. “This will create a highly liquid exchange.”
Apart from zero trading fees, what else is Digitex doing to ensure liquidity? “Speed is everything in futures trading,” says Todd, “that’s why we’re allocating a ton of our ICO resources into ensuring the trading interface is as advanced, easy to use, fast and robust as possible.”
It has a one-click ladder trading interface which will allow traders to trade in next to real-time, rather than going through several steps or multiple mouse clicks that could see their profits drop.
Another way that Digitex plans to increase liquidity is through their native DGTX token. While traders speculate over the price of Bitcoin, Litecoin, and Ethereum futures, they must purchase DGTX to realize orders.
This creates a constant demand for DGTX and ensures liquidity. It’s also the business model you can read about in the Digitex Futures whitepaper that allows them to remove the commissions from the trades.
Automated Market Makers
Digitex will also be using automated market makers to increase liquidity. These are basically trading bots with programmed algorithms designed to break even. 200 million tokens from the ICO were allocated to trading bots to deploy at their discretion, even during times of high volatility.
Liquidity Is Key
“Exchanges look to increase liquidity in a number of ways, often by offering a high selection of contract types, or an advanced user interface,” Todd explains, “Digitex removing commission fees, adding a one-click trading feature and automated market makers are all innovative ways of providing a high level of liquidity for our customers and accountholders.”
Liquidity is one of the most important components of a successful futures exchange. “Without a liquid trading environment,” says Todd, “an exchange will not survive in this highly competitive industry.”