Everything To Know About Forex Liquidity Providers (+ How To Get One)

The foreign exchange market (forex) involves high-volume CFD trades across the globe. It’s one of the most diverse and liquid markets available to brokers and high-net-worth individuals. 

To succeed in this market, forex brokers need liquidity to rapidly close positions, maximize their profits, and protect their clients’ investments. 

The good news is that forex liquidity partners offer liquidity to brokers to help them improve order execution speed and hedge against market volatility. 

Are you curious about how a forex liquidity partner can help you? In this guide, we’ll cover the basics of forex liquidity and give you a rundown of how a liquidity partner can benefit your brokerage. 

What Is Forex Liquidity?

Forex liquidity is the simplicity with which a currency pair can be bought or sold without significantly affecting its exchange rate. This type of transaction takes place over the counter. 

When people easily exchange a currency pair without market slippage, then it’s considered a liquid currency.

Liquidity can vary based on a wide range of factors, such as:

• Monetary policy: Forex liquidity can change depending on a country’s monetary policy. For example, a tariff increase or higher inflation rate can cause liquidity to fluctuate in global Fintech markets.
• Global credit supply increase: When the credit supply increases in a nation, it means that more people have money to make global trades on crypto exchanges. This can positively affect forex liquidity and stock market indices. 
• Global credit demand decreases: If the demand for credit decreases, it means that traders and brokers already have enough money to close positions on a trading platform. This is a positive sign that global markets are healthy. 

 

Liquidity can also affect trading conditions and spreads. The more liquid a currency pair is, the more advantageous trading conditions will be to brokers. This increases market buy-in, stabilizes cryptocurrency prices, and contributes to a healthy global economy. 

When a currency pair isn’t liquid, market volatility will follow. This means that prices will constantly fluctuate and cause slippage. When brokers aren’t sure if their expected trade price will mirror the executed price, they become less hesitant to engage the market. 

For this reason, reluctant brokers can cause market volatility to spiral out of control. This is where the importance of having a forex liquidity partner becomes clear. 

Forex liquidity partners offer efficient fiat on/off ramping, meaning they can facilitate forex conversions with little slippage. To accomplish this, these entities rely on banking relationships.

By partnering with a banking as a service (BaaS) provider, liquidity providers can broker white-label access to fiat on/off ramping to drive high-volume currency trades. 

What Are Forex Liquidity Providers?

A forex liquidity partner (LP) is a company that has trading assets in their own accounts to fulfill client orders from brokers. To maximize the liquidity of the forex market, LPs facilitate the transaction process by already having assets at their disposal.

This way, buyers and sellers aren’t waiting too long to complete their orders, and the market moves quickly. 

LPs can influence market depth by ensuring large market orders can be fulfilled without significantly affecting security prices. To keep worldwide markets healthy, there are strong liquidity providers, market makers, and brokers.

All of these parties participate in the forex market to keep liquidity high and maintain stable exchange rates. To better explain this point, let’s discuss the nature of forex liquidity providers. 

Roles of Forex Liquidity Providers

Forex liquidity providers act as counterparties during global transactions. Essentially, they execute a customer’s order by matching them with another buyer or their own assets. 

In facilitating forex transactions, liquidity providers act as market makers and greatly influence market volatility. The easier it is for liquidity providers to execute their clients’ orders, the more liquidity will exist in that market. 

Different Types of Forex Liquidity Providers

Many liquidity providers exist in the forex market to help facilitate efficient currency exchanges. The most common liquidity providers are:

• Banks: Banks are the most common liquidity providers. These financial institutions, which include a prime brokerage, amass large quantities of assets to offer competitive pricing to their clients. 
• Electronic communication networks (ECNs): These networks match algorithmic buy and sell orders from a wide array of traders, banks, and hedge funds. With deep access to liquidity pools, ECNs make sure traders can always find a counterparty. 
• Market makers: Market makers buy and sell assets from their own inventories to provide liquidity in global markets. As a result, market makers can provide liquidity even in volatile situations. 
• Hedge funds: Like banks, hedge funds can buy up large quantities of financial assets to boost their liquidity and offer competitive pricing to market participants. 
• Retail brokers: These brokers provide liquidity primarily to retail traders. Retail brokers can serve as intermediaries between financial institutions and retail traders to maximize liquidity pools and reduce slippage. This kind of liquidity aggregation is essential in modern forex markets to open up the possibilities for anyone to buy and sell. 

 

Tier-1, Tier-2, and Tier-3 Classifications

In order for financial institutions to provide liquidity pools to their customers, they must hold liquid assets. Financial assets held by banks and other intermediaries are classified into tiers:

• Tier 1: These are the precious assets a financial institution holds. Banks classify Tier-1 assets as their main earnings and equity, and it’s used to determine their financial strength. 
• Tier 2: Tier-2 assets are less liquid than Tier-1 assets. Banks hold them to supplement core assets in case of a massive shortfall and market volatility. 
• Tier 3: This is the lowest-quality asset that a financial institution can hold. In the past, banks held these assets to support their market risks. However, Tier 3 assets are currently being abolished after fallout from the Financial Crisis of 2008.

As you can see, liquidity partners that hold asset classes are more reliable in the long term. They have plenty of liquid assets on hand to stabilize a market’s position. 

Benefits of Getting a Forex Liquidity Provider

Liquidity providers can offer protection against market manipulation and other negative effects.

But that’s not all. Let’s examine some of the greatest advantages of partnering with a forex liquidity partner. 

Access to Deeper Liquidity Pools

Market manipulation is deliberately attempting to hijack market activity with misleading information and fraud. One of the most notorious forms of market manipulation is reporting false information to shareholders. 

During major company news releases, ask prices can fluctuate significantly. Depending on the validity of this information, price fluctuations can deter traders and create slippage. 

As a result, having access to deep market liquidity pools can offer more stable pricing during major news releases. The good news is that blockchain technology makes it possible for prime brokers to take advantage of deep liquidity pools.

In particular, AlphaPoint offers excellent liquidity solutions for brokers who want to hedge against chaotic news releases and protect their investments. 

Competitive Spreads and Pricing

Liquidity partners that own high-tier assets are more reliable in the long term. These entities have substantial liquid assets on hand to take on enormous market risk. 

They can also offer competitive pricing and spreads to their customers, which is ideal for long-term forex trading profitability. The rise of blockchain technology can potentially deepen liquidity pools for traders and maintain risk management on their end. 

The decentralized nature of blockchain technology makes it possible for financial institutions to use smart contracts to gather precious assets and build deep liquidity pools. 

Improved Trade Execution Speed

Forex liquidity partners rely on cutting-edge technological systems that support rapid trade execution.

The faster trades can take place, the more stable market prices tend to be. By partnering with a liquidity partner, you can ensure there are plenty of market participants ready to open and close positions quickly. 

This is essential for traders who specialize in scalping and want to secure short-term gains as quickly as possible. 

Reduced Slippage

Slippage is a negative attribute of any market. Liquidity partners keep markets transparent, reducing likelihood of slippage. 

For example, forex liquidity partners enhance trade execution to keep expected and actual currency exchange rates similar. 

More Stable Markets

Fortunately, liquidity providers can prevent flash crashes or extreme volatility. Liquidity ensures buyers and sellers can quickly close positions, creating a fair trading environment for everyone. 

Choosing the Right Forex Liquidity Provider

By now, you should know the importance of partnering with a forex liquidity provider. However, some providers are better suited for your trading needs than others. Here are some effective tips for choosing the right Forex liquidity provider.

Consider the Most Important Factors

Liquidity providers are ranked according to the reliability of their assets, technological infrastructure, and pricing:

• Assets: LPs that hold high-value assets are more valuable than ones that don’t. This means they have the capital to serve as market makers even during periods of low liquidity and rapid price fluctuation. 
• Technological infrastructure: LPs typically use electronic execution technology to provide their services. The best LPs use cutting-edge technology to quickly fulfill client orders. 
• Pricing: LPs charge a fee for providing liquidity to a market. Beware of LPs that offer complicated pricing structures, as they may not be financially suitable for the long term. 

Simply put, tier-1 liquidity providers are the best to work with. These providers use cutting-edge technology to positively influence forex markets. Doing business with a low-tier liquidity provider can be disastrous since they don’t have enough cash on hand to influence high trading volumes.

Understand the Significance of Electronic Communication Networks (ECNs) and Straight-Through Processing (STP)

Brokers and traders can run into a conflict of interest if it looks like a broker is capitalizing from a trader’s loss. With ECNs and STPs, brokers can only profit from spreads, eliminating this risk completely. 

Also, brokers can improve trade execution speeds by partnering with multiple liquidity providers and offering competitive spreads as a result. 

Review and Compare Offerings

It’s important to pay close attention when shortlisting liquidity partners. Specifically, watch out for hidden terms or conditions in LP contracts. 

For example, beware of LPs that don’t mention the classification of their assets. If this information isn’t listed in your contract, you could risk not getting an acceptable return for your investment. 

Having a clear understanding of what each provider offers can help you make the right decision and avoid buyer’s remorse. 

Legal and Compliance Considerations

Monetary policy regulations can affect any financial market. Thus, learning about the international regulations that influence liquidity provider operations is essential.

Since forex spans the globe, there are several regional regulations to consider. For example, the UK plans to introduce crypto regulations to prevent market abuse in 2024. 

Partnering with non-compliant providers can result in legal penalties and fiduciary ramifications for your clients. Most compliant LPs work with the Financial Action Task Force (FATF) to prevent global money laundering and terrorist activities. 

Harness AlphaPoint’s Expertise for Forex Liquidity Solutions

Liquidity solutions are essential to manage the relationship between brokers and traders. Having access to deep liquidity pools gives brokers the means to act in the best interest of traders and keep forex markets agile. 

With AlphaPoint, access to those deep liquidity pools is exactly what you get. Our team has over a decade of experience helping businesses innovate their financial offerings. Through our liquidity partners and Remarketer software, AlphaPoint provides customers with a wider range of high-quality liquidity products.

Our deep expertise in blockchain technology, exchange operations, and liquidity solutions put us at the forefront of the financial revolution. AlphaPoint can even offer valuable insights into how these concepts might shape the future of traditional financial and forex markets — and how our customers can use them to enhance their business offerings. 

Request a demo to see how AlphaPoint can empower your business with our liquidity solutions.