What Is an Order Book and How Does It Work?

Order books are used by cryptocurrency exchanges to facilitate liquid and transparent trading. Learn what they are and how they work.

Key Takeaways:

• An order book is a list of pending buy and sell orders for a cryptocurrency on an exchange. It is used to match buy and sell orders and determine market prices.
  
  
• Buy orders are listed at prices traders are willing to pay (bids), while sell orders are listed at prices traders are willing to sell at (asks).
  
  
• Order books increase liquidity by aggregating buy and sell supply and demand in one place, aiming for seamless order matching and price discovery.
  
  
• Order books can be used in both centralised and decentralised exchanges; there are alternatives, such as an Automated Market Maker (AMM) model used in decentralised exchanges, over-the-counter (OTC) trading, direct trading, and atomic swaps.
  

What Is an Order Book on a Crypto Exchange?

An order book is a critical component of most cryptocurrency exchanges that lists all pending buy and sell orders for a specific cryptocurrency. It aggregates real-time supply and demand data submitted by traders and allows exchanges to automatically match buy and sell orders.

The order book shows the prices at which traders are willing to buy (bid) and sell (ask) a cryptocurrency. Major crypto exchanges, like Crypto.com, typically utilise order books to facilitate trading.

Order books provide a certain level of transparency in the current state of the market, where traders can see current bid and ask prices, as well as order quantities at each price level. This gives market participants a clear view of where buying and selling pressure exists.

The order book thus acts as a pool where buyers and sellers interact to find counter parties for trades. It serves as the mechanism for transparent, continuous price discovery as new orders enter and are matched against the book. Traders can continuously refer to the order book to make trading decisions based on live supply and demand dynamics.

Key Components of an Order Book

A typical order book on a crypto exchange consists of several fundamental elements:

Price Levels

At its core, the order book showcases price levels representing both buying and selling interests. On the buying side, known as bids, it reveals the prices buyers are willing to pay for the digital asset. Conversely, on the selling side, referred to as offers or asks, it illustrates the prices that sellers are prepared to accept.

Order Quantity

Accompanying these price levels is information regarding the quantity of the cryptocurrency being transacted at each price level. This data serves as a vital tool for traders in assessing market sentiment. For instance, a large overhang of substantial sell orders within an order book may suggest a bearish outlook on that particular asset.

Market Depth

Market depth shows the aggregate volume of buy and sell orders across various price levels. This grants insight into market liquidity (i.e., the ease with which the cryptocurrency can be bought or sold).

Order Types

An order book contains the different order types available for trading at any given moment. These include limit orders, which stipulate a specific price at which the trader intends to buy or sell, as well as market orders, which execute at the prevailing market price.

Learn about different order types here.

Key Terms in Order Books

To navigate order books effectively when on the Crypto.com Exchange, familiarise yourself with these essential terms:

Bid-Ask Spread: This denotes the variance between the highest bid and the lowest ask prices. Market makers leverage the difference for profit. A smaller bid-ask spread typically indicates higher liquidity in the market, while a larger spread may suggest lower liquidity or increased trading costs.

Order Book Liquidity: Liquidity signifies the ease of trading a cryptocurrency without causing significant price fluctuations. A robustly liquid order book entails substantial participation from buyers and sellers conducting sizeable asset transactions. Moreover, a highly liquid market typically exhibits a narrower bid-ask spread than a less liquid one.

Top of the Order Book: This refers to the price extremes represented by the highest bid and the lowest ask within the order book.

Limit Order: This is an instruction to execute an order at a specified price (or a more advantageous one) compared to the prevailing market price.

Market Order: This instruction directs the execution of an order at the current best market price available.

Stop Loss: An order automatically triggers the sale of a cryptocurrency once the stop price is reached, serving to mitigate potential losses for traders. Learn how to place stop-loss orders with Crypto.com here.

Take Profit: This order specifies the price point at which to exit an open position to secure a profit, thereby maximising potential gains for the trader.

Slippage: Slippage arises when a trader’s order fills at a price different from the anticipated one. This occurs when an exchange cannot fulfil a market order at the desired price due to heightened volatility and scant order book depth.

Support and Resistance: Support marks a price level with significant buying interest to prevent the price from declining further, whereas resistance denotes a level with substantial selling interest to prevent the price from rising further.

How Do Order Books Work?

Now that we have familiarised ourselves with order book anatomy, let’s break down an order book example on market orders from this useful Crypto.com Exchange help section:

The section with the red-coloured figures shows the ask (sell) prices (sell order book) in which sellers want to sell. The amount is the total units of BTC looking to be traded at that price. The ‘Total’ column is simply a running total of the amounts.

Meanwhile, the section with the green-coloured figures shows the bid (buy) prices (buy order book) in which buyers want to buy. Again, the amount is the total units of BTC looking to be traded at that price, and the ‘Total’ column is a running total of the amounts.

When a new market buy order is placed that can fulfil the best available ask price, the exchange automatically matches and completes the trade. The same works in reverse for market sell orders matching the best bid. This constant matching of buy and sell orders is what drives price discovery and liquidity in a transparent market.

How to Use an Order Book

Whether traders are engaged in spot, options, or futures trading, order books offer them valuable insights for good trading decisions. However, experienced traders understand the limitations of order books and don’t solely rely on them. Instead, they integrate the information from reading order books with technical and market analyses.

Below is how order books can help traders make decisions:

Price Exploration

When looking at the market depth chart, spotting a surplus of buyers over sellers might hint at an upcoming bullish vibe. Conversely, if the chart tilts the other way, with more sellers in the mix, a downward trend might be on the horizon. 

It’s crucial to tread carefully during a downward swing. On the other hand, an upward trajectory in an asset’s price tends to loosen wallets, possibly fuelling greater adoption of the cryptocurrency.

Liquidity Gauging

When looking at market depth charts, wide, horizontal walls at certain price levels suggest abundant liquidity, while thinner walls signify areas of lower liquidity. A gentle slope, rather than a steep drop-off, indicates liquidity spread across various price points.

Grasping the liquidity of a specific market plays a pivotal role in determining which assets to engage with. For instance, a market with low liquidity may pose challenges in swiftly buying or selling assets. Furthermore, low-liquidity markets might be susceptible to manipulation by whales. Conversely, a highly liquid market facilitates rapid and seamless transactions for traders.

Pricing Your Order

Let’s take a look at our order book image again to learn how to price an order. You can see that on the buy side, the highest bid is at the top of the list in the buy order book (green section). This price is $10,694.74. On the sell side, the lowest ask is at the bottom of the sell order book. The price is $10,694.86.

If you want to buy BTC, you can offer the lowest bid price, which is $10,685.95 at the bottom of the screen. 

Benefits of Order Books

Order books on crypto exchanges provide several key advantages:

• Liquidity: By aggregating orders publicly on a single platform, exchanges foster enhanced market liquidity. Traders have heightened confidence through increased order-matching potential. Higher liquidity typically means tighter spreads and lower costs.

• Price Discovery: The order book mechanism allows market forces to determine prices organically. This promotes the discovery of fair asset valuations based on true supply and demand.

• Transparency: All traders typically have equal access to real-time pricing and order flow data to make informed decisions. 

• Efficiency: The matching mechanism paired with order books helps to facilitate rapid execution of trades. Traders can enter orders knowing they will be matched when criteria are met.

Alternatives to Order Books

While centralised crypto exchanges that adopt the order book model currently dominate the market, there are alternative trading mechanisms:

Decentralised Exchanges (DEXs)

With decentralised exchanges (DEXs), protocols like Uniswap typically operate using Automated Market Makers (AMMs) rather than an order book interface. Traders swap tokens directly with liquidity pools based on dynamic pricing formulas. While AMMs are currently generally considered less capital efficient compared to order books, they aim to provide a transparent and permissionless experience without depending on third parties.

OTC Markets

Institutional investors and large-volume traders often transact over-the-counter (OTC) cryptocurrency directly with market makers off-exchange due to size. However, the bespoke nature means no standardisation or visible price discovery for smaller (often referred to as retail) traders.

Direct Trading

Some trading platforms operate without order books and intermediaries like brokers, instead only facilitating direct trades between counterparties (a form of peer-to-peer transacting). However, this is a relatively ineffective mechanism for efficiency and liquidity.

Atomic Swaps

Atomic swaps enable peer-to-peer (P2P) transactions between individuals with different cryptocurrencies on two separate blockchains, eliminating the requirement for an intermediary (such as a centralised exchange). Atomic swaps allow users to exchange digital assets as per self-executing smart contracts.

Overall, alternative mechanisms provide differing trade-offs compared to order books. As decentralised finance (DeFi) continues to rapidly evolve, some hybrid or new paradigm may emerge that sparks innovation beyond current models. But order books will likely remain dominant amongst centralised exchanges for the foreseeable future. 

Conclusion

Order books show the prices at which traders are willing to buy (bid) and sell (ask) a cryptocurrency. They are typically utilised by centralised cryptocurrency exchanges, such as the Crypto.com Exchange, and offer several benefits like liquidity, price discovery, transparency, and efficiency.

However, there are alternatives to order books, such as the AMM mechanism used by DEXs, OTC trading, direct trading, and atomic swaps.

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation.

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a digital asset, it’s essential for you to do your own research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.