What is a Liquidity Provider?
May 20, 2021
A liquidity provider is a company whose role it is to quote both a buy and a sell price in a tradable asset, with the intention of making a profit on the bid/ask spread. Liquidity providers enable buyers and sellers to trade easily, without the need to find other individual traders, by making assets liquid i.e. easily convertible into cash.
Let’s take a quick look at liquidity itself. As we know, liquidity is a term that is commonly used in the markets, and can be described as the ease in which assets can be converted into cash. Liquidity is important for all tradable assets and is one of the most important factors in making a trade profitable. More liquidity in the markets means there is an easier transaction flow resulting in more competitive pricing. The provision of liquidity is therefore a key factor for the asset markets to properly function. But who provides liquidity and how? The role of a liquidity provider can be described as follows.
What is a Liquidity Provider? (LP)
A liquidity provider can be either a market broker or institution acting in the capacity of a professional market maker who works at both sides of a transaction.
There are various types of market participants who provide liquidity. These include central banks, commercial and investment banks, hedge funds, foreign investment managers, Forex brokers, retail traders and high net worth individuals. The top liquidity providers are called Tier 1 liquidity providers and comprise the largest investment banks with large Forex departments.
Considerations When Choosing a Liquidity Provider
It is important to select a liquidity provider with care. A chosen provider should be reliable and honest and come with a good reputation, with an easy-to-navigate website and the highest quality of online services that can be adapted to individual needs. Dishonest providers have been known to manipulate the market for their own good, causing serious damage to their clients, hence due diligence is always highly recommended. Here is a checklist of what to look for when assessing your own specific needs:
1. Liquidity Package On Offer
One of the most important steps for a broker to look for is the overall package on offer i.e. what assets and what kind of liquidity is provided. It is vital that multi-asset liquidity is made available by the liquidity provider along with access to historical data. Additionally, nominated accounts in different currencies are a plus sign, as is the ability to accept all the leading stable tokens and cryptos for deposit and withdrawal. These are just some of the aspects to consider, but it is essential to make sure that your exact needs are fully covered.
2. Fast Executions
It goes without saying that a liquidity provider should offer the fastest trade executions with re-quotes or slippage. This is very important in times of market news that is likely to cause a high impact.
3. Market Depth
Most liquidity providers use this aspect as a key selling point. Market depth is indeed a key consideration as it gives an indication of the liquidity and depth for a specific currency, for example. The higher the number of buy and sell orders at a particular price, the greater the market depth.
This is another key aspect and one of the foremost that companies will look for when seeking a liquidity provider. A liquidity provider’s pricing should include competitive spreads, not to mention low commissions and swaps without compromise on either side.
It is important to look for a liquidity provider that is regulated in the same way that brokers are. In this way, you can feel safe in the knowledge that they are operating under industry best practices within a notable jurisdiction and that a prime broker is backing them up.
6. Data Feeds
A liquidity provider should readily be able to provide reliable and stable client data feeds. Price feeds need to reflect real-time prices derived from all the appropriate exchanges and the interbank Forex market. Delays in price data delivery is more than likely to result in gaps.
7. Reporting Requirements
Reporting is vital for optimal functioning and in this respect, a liquidity provider must be able to provide an automated and robust reporting system. This will also allow for compliance with regulatory requirements. The kind of reports to look for are trade reports, FIX bridge reporting, swaps and rollover reporting and order book access.
Last but not least, a liquidity provider should be technologically competent and able to implement FIX Protocol and other APIs, MT4/MT5 bridge connections and FIX bridges.
Hence, besides knowing what a liquidity provider is, it is important to track down the best providers in the industry and check that they offer what your business needs. The best liquidity providers will tailor their service to fit your specific requirements. In this respect, B2Broker is one of the best liquidity providers and one of the most reputable in the industry.