FX Liquidity

FX liquidity describes how readily a currency can be bought or sold for another. A liquid market is one in which large amounts can be exchanged at any time, at a price close to the last one, with a narrow gap between buying and selling rates. An illiquid market is one in which trades are hard to arrange, prices jump when an order arrives, and the cost of dealing is high.

The phrase has a second, operational meaning in payments and treasury: whether a company has, or can obtain, enough of a given currency in the right place at the right time to meet its obligations. A remittance company with customers sending money to Kenya needs Kenyan shillings available for payout, and its access to them on acceptable terms is its FX liquidity in that corridor. Both senses apply the general idea of liquidity to the foreign exchange market.

No single number captures it. Common indicators are the bid-ask spread, with tighter spreads signalling a more liquid market; depth, the amount that can be traded at or near the quoted price, as shown by order book depth on electronic venues; price impact, how far a trade of a given size moves the rate; and turnover. The difference between the expected price and the price actually obtained is called slippage.

The standard source on turnover is the BIS Triennial Survey. Its 2022 edition recorded average daily turnover of about 7.5 trillion dollars across spot, forwards, swaps and options, and the 2025 edition a higher figure, making foreign exchange the largest financial market by volume. The US dollar is on one side of close to nine-tenths of all trades.

The market has no central exchange. Large international banks act as dealers, quoting two-way prices to clients and to one another, and are the traditional liquidity providers. Since the 2000s, non-bank electronic trading firms have become major participants, acting as a market maker on trading platforms. Smaller banks, brokers and payment companies obtain prices from these providers, often through a prime broker or an FX aggregator that combines quotes from several sources.

Central banks influence liquidity through their own operations and, in a crisis, by lending currency to one another through a central bank swap line, as they did with dollars in 2008 and 2020.

• By currency. Pairs between major currencies trade in enormous size at spreads of a fraction of a basis point for wholesale participants. Liquidity is lower in emerging market currencies and thinnest in an exotic currency, where there may be only a handful of dealers. The most liquid group is commonly identified with the G10 currencies.
• By time of day. Trading follows the sun from Asia to Europe to North America. Liquidity peaks when London and New York are both open and is poorest in the hours after New York closes. Currencies trade best during their home business day.
• By calendar. Holidays, month-ends and year-end reduce the number of active participants.
• By market conditions. Liquidity can vanish in moments of stress, when dealers widen quotes or withdraw. Sudden moves such as the Swiss franc's surge in January 2015 and the brief collapse of sterling in October 2016 occurred when orders met a thin market.
• By regulation. A restricted currency subject to exchange controls can be traded onshore only by licensed parties and for approved purposes, and offshore liquidity may be limited to non-deliverable contracts.

For a payment provider, market liquidity determines the price it pays to convert and how reliably it can do so. Operational liquidity determines whether payouts happen on time. Providers hold balances in destination currencies in nostro accounts or with local partners, a practice called prefunding. Money parked this way earns little, is exposed to exchange rate moves and cannot be used elsewhere, so the cost rises with the number of corridors served and falls most heavily on smaller firms. Planning and replenishing these balances is the subject of nostro funding.

In corridors with poor liquidity, providers face wide spreads, limits on the amounts they can convert in a day, delays in obtaining hard currency out of the country, and at times a gap between official and market rates. The spread between sending and receiving flows matters too: a corridor with payments in both directions lets a provider offset them and convert only the net amount.

Several efforts aim to reduce the amount of money tied up in foreign exchange settlement. Continuous Linked Settlement settles both sides of trades in its member currencies simultaneously and nets the funding required. Links between domestic instant payment systems allow currency to be exchanged at the moment of each payment. Some payment companies use stablecoins as a bridge between currencies, relying on stablecoin liquidity on exchanges in place of prefunded bank balances, though conversion into local currency at each end still depends on the depth of the local market.

Fragmentation remains a concern. Trading is spread over many platforms and bilateral channels, each showing part of the market, and the same nominal liquidity may be quoted in several places at once and disappear when taken in one of them.