Trading is a zero sum game which can sometimes be perceived as ruthlessly vying for other people’s money. Although the end objective of trading is to make profit, traders still provide a valuable service to the markets.
Here are three reasons why traders are important:
Traders risk capital to provide liquidity to a market. Most cryptocurrency projects would die without a market to trade them in. The more liquidity a market has, the more utility a cryptocurrency will have. Bitcoin is the most liquid crypto market in the world and for that reason it has more utility than all crypto projects combined, even ones with advanced capabilities.
Currencies are a medium of exchange and in the markets, liquidity is king. The exchanges are at the heart of the entire crypto ecosystem. Before bitcoin was assigned a value and traded on the market, it was just a worthless experimental token system.
- Miners would have no place to sell their coins to cover expenses, which would disincentive them from securing the blockchain.
- Merchants would not be able to easily convert into fiat to pay bills.
- New users would be limited in their options for purchasing coins.
- Remittance markets wouldn’t be able to easily convert in and out of local currencies.
#2: Price Discovery
Another important service traders provide is determining price discovery. Exchanges are an easy reference point for assessing the value of any coin. Without a solid form of price discovery backed by liquidity, free market currencies would lose confidence. Commerce would be fairly difficult without having a quick price reference because nobody would agree on value.
People believe in the value of bitcoin because it can easily be converted into their currency of choice. They may even accept obscure altcoins knowing it can be converted into BTC. The more liquidity traders provide, the closer one will be able to cash out coins at listed prices without excessive slippage.
There is no single exchange in crypto that determines price discovery and sometimes there are discrepancies in value. Arbitrageurs help bring global prices together by buying cheap on one exchange and selling it for more on others.
#3: Market Efficiency
Illiquid markets are inefficient due to high volatility and excessive slippage. The more liquidity a market has, the more stable and efficient the price will be. A simple example would be to compare the stability of bitcoin to a low cap altcoin.
Good traders make money off of exploiting market inefficiencies. This can lead to increased volatility during peak momentum until traders balance the markets back into a state of equilibrium. Extreme sell-offs will bounce due to closed shorts and dip buyers. Parabolic spikes eventually come back down to earth as traders take profit and exploit this inefficiency through shorting.