Define “Liquidity Provider” and Their Role in Reducing Slippage on an Exchange.
A liquidity provider (LP) is an individual or entity that places limit orders on both the buy (bid) and sell (ask) sides of the order book. By continuously quoting prices, they add depth and volume to the book, narrowing the bid-ask spread.
This increased liquidity ensures that incoming market orders can be filled with minimal price impact, thereby reducing slippage for all traders. LPs are essential for efficient market functioning.
Glossar
Liquidity Provider
Provision ⎊ A liquidity provider in cryptocurrency derivatives contexts furnishes capital to decentralized exchanges (DEXs) or automated market makers (AMMs), enabling trading by establishing bid-ask spreads; this process fundamentally addresses the inherent challenges of order book depth in nascent markets, and is critical for efficient price discovery.
Designated Market Maker
Role ⎊ A Designated Market Maker (DMM) is an individual or firm assigned by an exchange to maintain fair and orderly markets for specific securities or derivatives.
Reducing Slippage
Mitigation ⎊ Reducing slippage, within cryptocurrency, options, and derivatives, represents a suite of strategies designed to minimize the difference between the expected trade price and the actual execution price.
Incoming Market Orders
Flow ⎊ Incoming Market Orders represent immediate, non-passive demand or supply that is executed instantly against the best available limit orders resting on the order book.