Market makers are the invisible hand driving financial markets by providing balance and stability. For investors, knowledge about market makers is important to understand financial markets and to make informed investment decisions.
What Is A Crypto Market Maker?
Market makers are typically institutions that are tasked to facilitate the smooth trading of an asset increasing liquidity of that asset and cushioning prices from potential volatility caused by supply and demand.
In the crypto space, centralized exchanges use crypto market makers to increase liquidity and reduce price dislocation. This provides the latest real-time cryptocurrency price data and updates, such as the latest real-time cryptocurrency price updates from Gate.io. While decentralized exchanges primarily use Automated Market Makers, they can use Market Makers too.
In market-making operations, speed and technology are important to provide seamless liquidity for buyers and sellers. Automated algorithms are often used by crypto market makers to optimize trading activity and execute trades based on predetermined rules. These algorithms are often proprietary as they are coded and fine-tuned by the respective market makers. The combination of financial expertise and an efficient algorithm allows market makers to be responsive to ever-changing market conditions.
In this article, we’ll explain how crypto market makers improve market stability by facilitating liquidity and how better liquidity facilitates price discovery and price stability of an asset.
Understanding Liquidity
The role of a crypto market maker is to increase the liquidity of an asset. Liquidity simply refers to how easily you can buy or sell an asset without impacting the price.
● In a highly liquid market, plenty of buyers and sellers are present. It should be easy to find someone to trade with at a reasonable price within a relatively short period of time.
● In an illiquid market with few buyers or sellers present, prices offered may not have anyone accepting it for a prolonged period of time unless the price is much higher than the previous price offered.
So, liquidity is critical for a trading environment to be attractive to investors. This is the main reason why projects hire crypto market makers.
Better Liquidity Facilitates Price Discovery and Price Stability of An Asset
When it comes to price discovery, the two main forces are supply and demand. Crypto Market makers help facilitate both supply and demand forces to help provide an agreeable price for both buyers and sellers. This helps to cushion the forces of supply and demand and allows an asset price to stabilize at the appropriate market level.
Let’s say there is an asset called Token X. The market for Token X is not liquid, meaning there are only a handful of buyers and sellers.
● If an institution decides to buy up a large amount of Token X, demand for the limited supply of tokens left on the market increases sharply, causing prices to spike.
● On the other hand, if the institution decides to sell its entire stash of Token X – this would flood the market, increasing supply significantly. If there aren’t enough buyers to absorb this demand, the price of Token X will drop sharply in response.
Volatility can increase the level of uncertainty and risk in the market, making it harder for investors to make informed decisions and deploy capital effectively.
Therefore, a crypto market maker is important to help bring balance and stability to the changing market conditions.
How Do Crypto Market Makers Remain Profitable?
Exchanges or DEXes that hire crypto market makers to provide general liquidity for listed securities may be paid a flat fee, or earned from the spreads made through trades.
Projects that hire crypto market makers to provide liquidity for their specific token typically pay a flat fee, sometimes with a performance commission on top. Another model that market makers in cryptocurrency offer is a coin loan model which allows them an option to purchase the token in the future.
Of course, it’s not irregular for crypto market makers to sell assets at a loss – after all, they are obligated to hold certain amounts of an asset in order to provide liquidity for the stipulated uptime and fulfill all orders placed instantly.
Market makers are also allowed to take a cut, known as the bid-ask spread. This is the difference between the bid price, the highest price they’re willing to offer for an asset, and the asking price, which is the lowest price they’re willing to accept it for.
Market makers also earn through the arbitrage of prices between different exchanges. The process is the buying of cryptocurrency in one market and selling it in a different market at a higher price, earning the price difference in profit.
What Other Benefits Do Crypto Market Makers Provide?
By buying and selling assets constantly, crypto market makers narrow the bid-ask spread. A narrow bid-ask spread is generally considered favorable to investors as the price offered is less far off from the accepted price. With a reasonable price gap between the offered and accepted price, people can be encouraged to participate in trading these assets.
Market makers also help to increase the depth of order books, which is a digital record of the history of buy and sell orders of a particular asset. To inform investors, the order book is a helpful tool to find out the health of the asset – it reveals the number of orders that are open at a range of prices, as well as any imbalances or resistance levels. Deep order books can attract investors as it indicates a liquid market, which can reduce the risk for investors.
Recap
● Market making is the act of facilitating the buying and selling of securities, and promoting liquidity in the market.
● They help in price discovery prices by cushioning the supply and demand forces and stabilizing prices to the market level. They make profits by taking a cut, known as the bid-ask spread and arbitrage across exchanges.
● Market makers play a crucial role in financial markets by facilitating liquidity and market stability, and their presence is essential for attracting and retaining investors.
