Liquidity Is Invisible Until It Isn't

Two screens show the same price. One market can absorb a large order without flinch­ing. The other would move several per cent. Nothing on either screen tells you which is which.

That is the dif­fi­culty with liq­uid­ity. It is the most impor­tant prop­erty of a market for anybody who trades size, and it has no ticker symbol. It lives below the dis­played quote, in how much is offered at each price behind the best one, how quickly those offers come back after they are taken, and how many of them are real. Most of the time it is invis­i­ble because it is plen­ti­ful. It becomes visible at the moment it dis­ap­pears.

Same price, dif­fer­ent market

Our own capture con­tains a clean example, one second apart on the same venue. At 537 mil­lisec­onds into our second, Binance's best offer for bitcoin was $75,844.01. At 1,597 mil­lisec­onds, just after the second ended, it was $75,840.34. The two prices are $3.67 apart, half a basis point, close enough that nobody glanc­ing at a screen would notice any change.

The markets under­neath were not close. At +537 ms the twenty visible levels on the sell side held $30,094. At +1,597 ms they held $638,838, about 21 times as much.

Send the same order into both. A $25,000 pur­chase against the first book would have used 14 of the twenty levels and paid 0.11 bp over the screen. Against the second book it would have filled at the best offer. A $250,000 pur­chase could not have been priced at all from the first book, and would have cost next to nothing against the second. Same price. Different market.

Where it went

The thin book had a cause. It sat in the middle of a burst of buying that ran across all five venues, after the large order on page 44. Market makers who had been offer­ing size either sold it or moved away. Within about a second they were back, at slightly higher prices, deeper than before. On a calm day that cycle happens con­stantly and nobody sees it, because the price barely moves.

Spreads tell a similar story. At the start of the second, the gap between best bid and best ask was a cent on Binance and Coinbase and ten cents on Bybit, Gate and OKX. By the end of the second the gap on Coinbase was $9.37 and on Gate $3.60. On the other three it had not moved. Nobody announced it. On two venues the people willing to act stepped back, and the price stayed on the screen as though nothing had hap­pened.

When it goes all at once

Those were small, ordi­nary with­drawals, repaired within a second. Larger ones are the moments market history remem­bers. On 6 May 2010 US equity markets fell and recov­ered within about half an hour, and some shares traded at a cent or at $100,000 as market makers' place­holder quotes, known as stub quotes, sud­denly became the only orders left in the book. On 15 January 2015, when the Swiss National Bank stopped holding the franc below 1.20 per euro, liq­uid­ity in one of the world's most traded cur­rency pairs van­ished for minutes and prices gapped by double digits in per­cent­age terms.

In each case the dis­played price before the event said nothing about what was about to happen, because a dis­played price describes the best offer and says nothing about the ones behind it. Depth that has been there every day for years prom­ises nothing. The orders that make it up are free to cancel, and they cancel together, because the people who place them are react­ing to the same infor­ma­tion at the same time.

Why the makers leave together

It is tempt­ing to see the with­drawal of market makers in a fast market as deser­tion. From the inside it looks like arith­metic. A market maker earns the spread on trades with people who have no special infor­ma­tion, and loses on trades with people who know some­thing she does not. In calm markets the first kind dom­i­nates. When prices start moving fast, a larger share of the orders arriv­ing are from people react­ing to news she has not yet seen. Every quote she leaves in the book becomes an option she has given away for free.

So she widens her spread, reduces her size, or leaves. So does every other maker running a similar model on similar data, at the same moment. No single maker ever promised the liq­uid­ity that had been there for years. It was the sum of many sep­a­rate deci­sions to stay, and the same signal reverses all of them.

That is also why it comes back. The first makers to return to a thin book are paid well, in wide spreads, for taking the risk. Within our frozen second, the Binance book went from thin to deeper than it had started in about one second. On the days market history remem­bers, the same process took minutes, and in a few cases exchanges had to stop trading to give it time.

Reading what cannot be seen

Professional traders there­fore watch things the price does not show: how much is offered within a few basis points of the best price, how that changes through the day, how quickly the book refills after it is hit, how wide spreads are rel­a­tive to their normal range. None of them is a fore­cast. Each is a way of asking the market how much weight its current price could bear.

They also know that the most dan­ger­ous moment is not a thin book but a thick one that nobody has tested. Page 42 shows Binance's visible sell side over the minute around our second. Three seconds before it, more than a million and a half dollars was on offer. Inside the second, thirty thou­sand. Nothing about the dis­played price warned of either number.

Same number, one second apart. Behind the second one stood many times the money, and the screen never said a word about it.