An iceberg order refers to a type of order that breaks up large orders into smaller limit orders to conceal the transaction size and avoid spikes in the price level of an asset. This is mainly used by institutional investors looking to make sizeable trades in the market, large enough to topple the market price of assets in a short time frame if detected.
Institutional traders create an iceberg order on a trading platform to automatically break down the large order into smaller chunks, executed one after the other to avoid such price impact.
Iceberg Orders: How Large Players Hide Size
Iceberg orders have existed and are used in the traditional financial industry. However, the benefits of iceberg orders are primarily evident in the cryptocurrency markets as it is highly responsive to news and rumours.
When institutional traders plan to execute a seemingly large order without revealing the actual order quantity, they simply place an iceberg order. For example, suppose a wealthy investor or institution is looking to purchase 5,000,000 units of a crypto token with a unit price of $20 and an average daily trading volume of 400,000 units.
This order is more than 10 times the trading volume of the crypto asset; hence such an order appearing on the limit order book of an exchange would simply send the asset’s value through the roof. The investor may eventually have to purchase the asset at higher prices or settle for fewer units of the crypto asset.
Breaking Things Down
Depending on the investor’s conditions, an iceberg order would simply split the entire order and execute them in bits of 5000 units.
The trade is executed such that the visible portion of the entire trading volume is 5000 units at each point in time. The hidden portion of the order is only revealed in this increment, triggered by the completion of the prior order.
This means that instead of having an aggressive buy limit order appear on the order book, the trade is executed in bits, typically spanning more than one trading day. This reduces the chances of the trade being spotted and ensures the entire order is completed at a reasonably optimal price.
Also, given the volume of trading activities be executed, iceberg orders also contribute to the order book liquidity of an exchange.