The Key Role of Crypto Market Makers in Market Liquidity

Market makers, whether they are individuals or financial entities, have the important role of facilitating the buying and selling of securities in financial markets. Their presence is crucial for maintaining adequate liquidity in the markets. These entities, often referred to as the backbone of the financial trading world, ensure that trading remains efficient and that the order book is always filled with buy and sell orders. This article explains, what is a market maker in crypto, outlining the functions, mechanisms, and types of market makers that operate in this sector.

What Do Market Maker Services Include?

Crypto market making services encompass a range of activities aimed at creating a healthy trading environment:

  • Maintaining an active order book. Market makers ensure there is always a sufficient number of buy and sell orders on the books, which helps minimize the spread between the asking price and the bidding price.
  • Ensuring liquidity. By buying and selling cryptocurrencies non-stop, they provide liquidity, which in turn helps traders execute their orders without causing significant price shifts.
  • Price stabilization. Through their constant trading activities, market makers can help dampen price volatility, providing a more stable trading experience for everyone in the market.

How Does Crypto Market Making Work?

Answering the question “How does market making work in crypto?” involves recognizing the strategies employed by market makers to manage and lower risks while providing necessary market liquidity.

Here are the most popular strategies an average market maker in crypto uses:

  • Two-legged trading. This strategy involves placing buy and sell orders simultaneously to capture the spread between the bid and ask rates. Market makers using this strategy ensure they are always ready to buy or sell at predetermined prices, contributing to the market’s liquidity. The key to two-legged trading is to update these orders in real-time based on market conditions. Market makers adjust the prices of their bids and asks as the market moves to remain competitive and to manage their exposure to price movements. This strategy is particularly effective in markets with high volatility and trading volume, as it allows market makers to adapt to changes and maintain profitability quickly.
  • Mean reversion crypto market making strategy is based on the assumption that prices tend to move back toward the average over time. Market makers who employ this strategy typically calculate the average price over a certain period and then place trades that anticipate the reversion of the current price back to this average. In practice, if the price of a cryptocurrency significantly deviates from its average, the market maker might place trades, assuming it will revert back to that average. It can involve buying when the price is below the mean and selling when it’s above. This strategy requires sophisticated statistical models to determine the mean accurately and to forecast price movements effectively.

Types of Crypto Market Makers

Here are the common types of cryptocurrency market makers:

  • Proprietary trading firms. These firms utilize their capital to engage in market making, buying and selling a wide range of assets to manage their liquidity. By using advanced trading algorithms, they can respond swiftly to market changes, helping stabilize the prices of crypto and reducing market volatility.
  • Brokerage firms. Serving as intermediaries, brokerage firms facilitate transactions between buyers and sellers, earning their income from fees and spreads. These firms play a critical role in cryptocurrency market making by enabling retail and institutional investors to access cryptocurrency markets more seamlessly. They ensure that their clients can execute large trades without causing significant impacts on the market prices.
  • Exchange-affiliated market makers. Many cryptocurrency exchanges establish their own in-house market makers to ensure that their trading platforms consistently have sufficient liquidity. This arrangement helps maintain tight bid-ask spreads and allows for higher trading volumes without large price fluctuations. Additionally, these market makers help in attracting and retaining users, as traders generally seek out platforms that offer better liquidity and more stable trading environments.

How Do Market Makers Make Money?

Market makers in the cryptocurrency sphere generate income through several avenues:

  • Bid-ask spread. The difference between the buy price and the sell price in the order book is a direct source of profit for market makers.
  • Trading volume. By increasing the trading volume, market makers can capitalize on small price differences at high volumes.
  • Rebates. Exchanges often offer rebates to market makers as incentives for providing liquidity, which can be a significant revenue stream.

Market making in crypto provides the necessary liquidity and stability required for efficient trading. The role of a market maker in crypto is multifaceted, involving intricate strategies and a deep understanding of market dynamics. Whether through proprietary trading, brokerage services, or direct exchange affiliations, these entities help bridge the gap between supply and demand, ensuring that cryptocurrencies can be traded smoothly and efficiently.