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Market Maker: What Does It Mean in Crypto?

Updated 2023-08-17 17:33:59

The cryptocurrency market has transformed the world of finance by introducing different concepts and terminologies critical to comprehend its dynamics. One such concept is the market maker, a key factor in guaranteeing liquidity and efficiency in crypto markets. In this post, we will look at the role of market makers in the crypto ecosystem and their importance in providing liquidity.


What is Market Maker?

A market maker helps maintain liquidity in financial markets


A market maker is an individual or business that helps to maintain liquidity in financial markets by enabling the buying and selling of assets. Market makers operate as middlemen between buyers and sellers, providing a steady flow of trading activity and adequate liquidity in the market.


A market maker's principal function is to give bids and ask prices for assets. The bid price is the largest amount that a buyer is ready to pay for an asset, whereas the asking price is the minimum price a seller prefers to sell the asset for. Market makers create a market where traders can buy and sell assets anytime by regularly quoting these bids and asking prices.


Market makers are well-known for offering competitive bid-ask spreads. The bid-ask spread is the difference between the bid and ask prices and indicates the market maker's profit margin. They attract traders and give them a cost-effective means to enter and exit positions by offering tight bid-ask spreads.


How Do Market Makers Provide Liquidity?

How Do Market Makers Provide Liquidity?


Market makers are essential in supplying liquidity to financial markets, including cryptocurrency. The ease with which a product can be bought or sold without materially affecting its price is called liquidity. Market making provides a steady flow of trading activity by enabling the purchase and sale of assets. A closer look at how they provide liquidity follows:


Bid and Ask Prices

Market makers constantly quote bids and ask prices for assets in which they specialize. The bid price is the highest amount the market maker is ready to pay to buy the asset, while the asking price is the lowest price they want to sell it for. They create a market in which traders can promptly execute trades at the indicated prices by offering these prices.


Order Absorption

When traders submit market orders to purchase or sell assets, they function as counterparties and absorb these orders. If a trader wishes to buy an asset, the market maker sells the item from their inventory to the trader. Similarly, if a trader wishes to sell, the market maker purchases the trader's asset. This procedure assures that there is always a willing buyer or seller accessible, which improves liquidity.


Maintaining Competitive Bid-Ask Spreads

Market makers strive to keep bid ask spreads competitive to attract traders and increase trading activity. The bid-ask spread is the variation in market price between the bid and ask. They offer traders better pricing and reduced transaction costs by narrowing the gap, making it more appealing to engage in the market.


Sufficient Inventory

Market makers must keep an inventory of assets to perform their duties properly. This inventory enables them to execute trades rapidly and provide liquidity. They can match trader demand by holding sufficient assets, facilitating the smooth execution of trades with little price slippage.


Market circumstances

Market makers constantly monitor market circumstances, alter bids, and ask prices accordingly. They consider supply and demand dynamics, volatility, and overall mood. They assist in stabilizing market prices and maintaining liquidity by responding to market conditions.


Adding Depth to the Market

Market makers add depth to the market by ensuring traders can transact at numerous price levels. This depth enables traders to purchase or sell assets in varying volumes and at varying prices, increasing flexibility and lowering the influence of more significant deals on the asset's price.


Types of Market Makers

Market makers are classified according to their target audience, trade volume, and specialized functions within the financial ecosystem. Three categories of them are as follows


Retail Market Maker

Retail Market Maker - Types of Market Makers


Individual retail traders rely on retail market makers to provide liquidity and facilitate trading. They run on retail trading platforms that are open to ordinary investors. Retail market makers play an essential role in ensuring a seamless trading experience for retail traders by providing competitive bid-ask spreads and promptly executing trades. They conduct fewer trades than institutional market makers but serve more regular participants.


Online brokerage platforms and retail-focused cryptocurrency exchanges are frequently associated with retail market makers. Their services help to increase the accessibility and liquidity of these platforms, making it easier for individual traders to engage in the market. Retail market makers also assist retail traders in lowering transaction costs by providing competitive pricing and reduced bid-ask spreads.


Institutional Market Maker

Institutional Market Maker - Types of Market Makers


Institutional market makers, which include hedge funds, asset managers, and institutional trading desks, primarily serve more prominent investors. They handle large trading volumes and specialize in providing liquidity to institutional investors in both traditional and cryptocurrency markets.


Institutional market makers frequently use sophisticated trading algorithms and innovative trading instruments. They provide tailored liquidity solutions and trade execution on behalf of institutional clients to ensure seamless trade execution with minimal market impact. Institutional market maker participates an important role in meeting the liquidity requirements of large-scale institutional traders, hence contributing to market efficiency and stability.


These designated market makers may work directly with institutional clients or as part of larger financial organizations like investment banks or proprietary trading firms. Their specialization is managing bigger trading volumes, dealing with complex order flows, and understanding the complexities of institutional trading.



Wholesaler - Types of Market Makers


Wholesale market makers, often known as wholesalers, specialize in high-frequency trading and deal execution. They frequently work behind the scenes, interacting with exchanges, brokers, and other market participants to ensure that trades are executed efficiently.


Wholesalers use their technology-driven trading infrastructure to execute trades rapidly and supply market liquidity. They are critical in increasing market depth and executing deals on behalf of other market players. Wholesalers may use complex algorithms and methods to capitalize on minor pricing differences and market inefficiencies.


Wholesalers generally operate in the shadows, performing many trades and profiting from little price differences. They help to increase market liquidity by conducting trades quickly and effectively, which benefits both regular and institutional traders.


Automated Market Makers

AMMs are decentralized protocols that use smart contracts to offer liquidity and autonomously establish asset pricing


What are automated Market Makers?

In recent years, a new form of market maker known as Automated Market Makers (AMMs) has emerged in the crypto market. AMMs are decentralized protocols that use smart contracts to offer liquidity and autonomously establish asset pricing. They have transformed the way liquidity is provided in the cryptocurrency ecosystem. AMMs run on decentralized exchanges (DEXs), removing the need for traditional intermediaries such as centralized exchanges or market making organizations. These protocols enable users to trade with the smart contract directly, eliminating the need for a counterparty to facilitate trades.


How do AMMs work?

AMMs use liquidity pools rather than standard order books and order-matching algorithms. These pools are where liquidity providers deposit their assets, which are then used to execute trades. Liquidity providers are compensated with pool tokens, which represent their part of the pool's liquidity.


AMMs use mathematical formulas, which are typically based on the concept of constant product formulas, such as the Automated Market Maker (AMM) model proposed by the Uniswap protocol. The asset prices are determined by these calculations based on the relative supply of assets in the liquidity pools. Prices are automatically changed with each trade, ensuring that trades can be completed at any moment without the presence of a counterparty.


How can AMMs benefit?

One of the most important characteristics of AMMs is that they provide liquidity for any token listed on the decentralized exchange, including those with low trading volumes. This differs from traditional market makers, who may only provide liquidity for more liquid assets. AMMs democratize liquidity provision by allowing anybody to become a liquidity provider. Users can contribute their assets to the liquidity pools and earn a portion of the protocol's trading fees. Individuals can now participate in the market making process while earning passive income from their investments.


Because of its decentralized structure, accessibility, and capacity to provide liquidity for a wide range of assets, AMMs have grown in popularity in the crypto world. They've also fueled the emergence of decentralized finance (DeFi) by enabling a diverse range of financial applications like decentralized lending, borrowing, and synthetic asset trading.


What can be the setback of AMM?

While AMMs have numerous advantages, they are not without drawbacks. Because AMMs are automated, they are susceptible to impermanent loss, which is a transitory loss of value that liquidity providers may face when the relative prices of assets in liquidity pools change. Furthermore, the reliance on mathematical formulas and smart contracts adds new dangers, such as code vulnerabilities or potential formula manipulation.


How do Market makers make money?

How do market makers make money?


Market makers are critical in supplying liquidity to financial markets, including the cryptocurrency market. While their primary goal is to ease trading and maintain market efficiency, market makers benefit through a variety of techniques. Let us look at how they generate money.


Bid-Ask Spread

The bid-ask spread is the difference between the bid price (the buying price or the amount a market maker wants to buy an asset) and the asking price (the selling price or the amount at which they want to sell it). They earn from the bid-ask spread by purchasing assets at a discount and selling them at a premium. They intend to entice traders by offering competitive spreads while maintaining a healthy profit margin.


Trading Volume

Market makers get money based on the amount of trading volume they assist. They receive fees or commissions on trades executed by traders. The more trade activity they handle, the more money they make. They, particularly those who serve institutional clients, handle significant transaction volumes, which contribute to their revenue stream.


Market Data and Information

Market participants have real-time access to market data and information. To make informed trading decisions, they study market patterns, order flows, and other pertinent data. Market participants can take advantage of this knowledge advantage to profit from market movements, such as buying assets at the time when prices are low and selling them during the prices are increasing.


Rebates and Incentives

In some circumstances, exchanges or trading platforms give rebates or incentives to them in exchange for providing liquidity. These incentives may take the shape of lower trading fees, additional awards, or other advantages. They can use these initiatives to increase their profitability and motivate them to deliver constant liquidity.


Arbitrage Opportunities

Market makers are uniquely placed to discover and capitalize on arbitrage opportunities. Arbitrage is the practice of taking advantage of market price disparities between marketplaces or trading venues. They can profit from these price differences by immediately purchasing assets from one market at a lower price and selling them in another market at a higher price.


Specialized Trading methods

To gain profits, market makers may adopt specialized trading methods. Statistical arbitrage, market making algorithms, and high volume trading are examples of such tactics. Market makers hope to capture modest price differences, leverage market inefficiencies, and earn consistent profits by employing these advanced tactics.


Benefits of Market Maker

3 Benefits of Market Maker


Market makers provide various advantages to financial markets, including the cryptocurrency market. Their presence improves market efficiency, liquidity, and the overall trading experience. The benefits are


Increased Liquidity

Market makers are critical to the market's liquidity. They provide a constant flow of trading activity by continuously quoting bid and ask prices and acting as counterparties to traders. Because of this liquidity, traders may complete trades quickly, even for assets with modest trading volumes. They increase market depth and decrease price slippage, hence improving total market liquidity.


Narrow Bid-Ask Spreads

Market makers make every effort to provide competitive bid-ask spreads. Tight bid-ask spreads lower trading expenses for participants and makes it easier to initiate and exit positions. They improve trading efficiency and attract more traders to the market by offering narrower spreads. Lowering transaction costs and boosting price discovery benefits both retail and institutional investors.


Price Stability

Market makers are critical in lowering price volatility. Large purchase or sell orders can generate huge price movements in the market. They absorb these orders by taking the other side of the trade, which dampens the impact on pricing. By eliminating uncertainty and fostering smoother price swings, price stability benefits traders, investors, and the overall market ecology.


Risks from Market Maker

3 Risks from Market Maker


While market makers play an important role in preserving liquidity and market efficiency, their activities are not without danger. Market participants must be aware of these risks and comprehend the potential difficulties connected with these designated market makers.


Market Volatility

Market makers are vulnerable to market volatility, which can have an influence on their profitability. Sharp and fast price swings can cause higher bid-ask spreads, making it more difficult for them to maintain tight spreads and properly manage their inventory. High volatility can also result in bigger price swings, which can result in losses for them with significant positions.


Counterparty Risk

Market makers are exposed to counterparty risk, particularly in over-the-counter (OTC) markets where they conduct direct transactions with clients. If a counterparty is unsuccessful to meet its regulations or defaults on a trade, the market maker may face financial consequences. Due diligence, risk assessment, and the establishment of strong legal agreements and collateral requirements all help to reduce counterparty risk to some extent.


Liquidity Risks

Market makers suffer liquidity risk since they offer liquidity to the market. Market conditions can fluctuate quickly, causing changes in market demand and supply dynamics. Market participants must manage their inventories and provide adequate liquidity to meet client demands. In illiquid markets or during instances of market stress, they may find it difficult to execute deals or liquidate positions without incurring considerable fees.



Market makers play an important role in financial markets, including the cryptocurrency market, securities market, and other markets by providing liquidity, improving market efficiency, and making trading more convenient for participants. They help to stabilize prices, decrease bid-ask spreads, and boost market accessibility, which benefits both retail and institutional investors.


Finally, market makers are an important part of the financial ecosystem since they facilitate smooth trade, increase liquidity, and contribute to market efficiency. Their capacity to strike a balance between profitability and liquidity provision is critical to their long-term viability and the overall functioning of the markets. Market makers will continue to play an important role in establishing the crypto market's liquidity landscape and nurturing a vibrant trading environment as it evolves.