Liquidity by CoinMarketCap
Liquidity by CoinMarketCap works by taking a few variables into consideration:
The distance of the order from the mid-price
The size of the order
The relative liquidity of the asset in question
In measuring liquidity effectively, it is important to consider the distance of the order from the mid-price (calculated by [best bid + best ask] / 2 ). The further the order from the mid-price, the less weight should be given to the order as it becomes less relevant for traders. For example, an order placed at 0.5% from the mid-price would be given a heavier weight than an order that is placed >1.5% from the mid-price. This is because the resting order nearer the mid-price has a higher probability of getting filled, thus needs to be accorded more weight than the order further away.
The size of the order is important as liquidity seeks to measure the depth of the order book. The larger the orders on the order book, the higher the Liquidity score of the market.
In addition, the Liquidity metric has been designed to measure the liquidity of the market in an adaptive manner. Liquidity between different markets and cryptoassets can differ a lot - the metric takes this into account and the algorithm adapts to this difference to return the fairest result possible. This means that the more liquid the market pair is, the more aggressively orders get discounted as they move further from mid-price. This is in line with the idea that we want to accord more weight to orders that have a higher probability of getting filled as they represent liquidity that matters to traders.
The end result of adopting such a methodology is the ability to return a singular number that reflects the effective liquidity of any market pair. The weight given to the orders varies depending on the absolute order-book depth of the market pair in question and the distance it rests from the mid-price. This allows us to fairly compare the liquidity between all markets we track, regardless if it is a liquid asset like Bitcoin or the 1000th ranked coin/token. We refrained from using a static % depth as we recognized the difference in absolute liquidity between the various cryptoassets.
The adaptive methodology applied makes our metric difficult to “game” as orders would need to be placed very close to the mid-price or risk being counterproductive to the Liquidity score we return. We hope this results in more liquid markets for the entire cryptoasset space as exchanges and market makers prioritize posting effective liquidity instead of increasing volumes.
Lastly, the reported Liquidity is calculated by polling the market-pair at random intervals over a 24-hour period and averaging the result. Orderbook depth of any given market changes constantly due to immediate market conditions. In order to make Liquidity fair with respect to differences in global time zones, a rolling average over a 24-hour period is implemented.
How do I interpret the Liquidity metric?
The algorithm returns a number that is indicative of the average liquidity of any given market pair over a 24 hour period. This number can be used to compare liquidity between different market pairs, regardless of Base or Quote asset. The higher the result, the better the liquidity of the market pair.
Our Liquidity metric is more than a mere summation of order book depth. As we realize that working orders only matters insofar as the probability that they get filled, orders further away from the mid-price of any market should be given less weight in determining the liquidity of the market. Thus, we believe that our Liquidity metric is a fairer way of summarising the liquidity of any market pair, regardless of Base or Quote asset, than any other “static polling” of order book depth.