What is Price Improvement?
Price improvement refers to the cost savings that result when an order is executed at a price that's better than the best market price. In the US stock market, price improvement happens when an order is filled within the National Best Bid and Offer (NBBO), a representation of the "best" price. According to official disclosure, which arguably understates (see below) the true savings, retail investors enjoyed $3.6 billion of price improvement in 2020.
NBBO is a consolidated view of the highest bid and lowest offer price from all exchanges and public trading venues. In the US, there are 10+ stock exchanges (e.g. NYSE, NASDAQ, IEX, CBOE etc.) registered with the SEC.
Let's take a look at some examples.
Price improvement example: a token has a bid of $14 and offer of $15 on an exchange but a market maker might quote $14.3 to buy and $14.7 to sell for retail order flow. A retail investor would have paid $14 to sell but now he can sell for $14.3 to the market maker – a price improvement of $0.3. On the other hand, he would have paid $15 to buy on the exchange but now he can buy for $14.7. The market maker makes $0.4 from the spread and can pay the brokerage firm $0.1 (known as payment-for-order-flow) while still netting $0.3. Market makers don't have to improve prices on all orders, but they are incentivized to do so because they compete with each other for order flow. In the stock market, brokerages rank market makers based on price improvements they offered over periods of time.
Size improvement example: In addition to price improvement, market makers can provide size improvement, which happens when the number of filled shares is greater than what's available at the best market price. The token has 150 tokens offered at $15 but an incoming buy order of size 525 is filled at $14.7, the price improvement is $0.3 per token. However, when taking into account the volume-adjusted price, the real savings is around $1.3 per token. This is because if the order was routed to the exchange, the trader would’ve paid 150 at $15, 175 at $16, and 200 at $17 for an average of around $16. Market makers in a PFOF model can fill orders at the best price regardless of size up to a reasonable amount.
Price Improvement in Crypto
DFlow will allow market makers, for the first time, to provide price improvements to crypto retail investors. Existing venues like centralized exchanges (e.g. Binance) and AMMs (e.g. Uniswap) are not capable of providing price improvements and do not have best-execution guarantees.
In addition, DFlow will improve on transparency and disclosure of price improvement.
Firstly, existing reporting (i.e. Rule 605 reports) in the traditional market does not account for the size of a trade relative to the NBBO (which is only top-of-the-book) and therefore, excludes the benefits of size improvements. DFlow accounts for size improvement when reporting the amount of real savings to retail investors.
Second, the NBBO is a somewhat controversial concept because the calculation for determining the best market price is not optimal, resulting in cases where there is actually a better price for orders under certain sizes. DFlow ensures orders are executed against the decentralized Consolidated Best Price and will make public the methodology for calculating price improvement to improve visibility.
Third, reports are not easily readble or accessible for most people and especially for retail investors. The DFlow Dashboard is the first-of-its-kind explorer for enhanced live reporting of order handling and execution. Some of the statistics include:
- Total amount of price improvement
- Average percentage of price improvement
- Number of tokens improved over the CBP
- Percentage of orders price improved