April 02, 2020 |James Messi
Market Makers: Crypto Markets Edition
What is a Market Maker?
A market maker also known as a “liquidity provider”, is a person or company that quotes orders on both sides of the orderbook (both bid and ask) at any given time. Market makers profit by facilitating and completing orders with other market participants trading financial instruments on open exchanges.
For more basic information on market makers follow the link below:
What does a Market Maker do?
Market makers are a cornerstone exchange participant tasked with the role of facilitating the buying and selling of financial instruments on publicly traded markets. Traditionally market makers profit on the difference between the bid and the ask, which is known as the spread. One of the key performance indicators that a market maker is judged by is on the size of the spread. A market maker has to facilitate high volumes of trades to profit from their activities. Not only does there need to be a competitive spread, but additionally a market maker must ensure they are quoting large enough order sizes where serious traders can easily get in and out of positions. Without a competent and motivated market maker staying busy a trading pair will exhibit large spreads leading to significant slippage, which will lead to financial losses for traders. If these conditions were to persist, traders will have no other option to abandon those pairs in search of better maintained order books.
Don’t know what a liquid and well maintenanced market should look like?
Here is a good example!
What’s life for Market Makers in crypto?
In the Digital Asset (DA) arena market makers are as important a player to their counterparts in traditional financial markets if not more essential. DA market makers must cope with two unique challenges when executing their role in an immature industry. The first unique challenge is market makers are required to hold assets that experience extreme volatility. That means there is significant risk to deployed capital, because the assets market participants are forced to hold can experience massive price swings not seen in traditional financial sectors. The second challenge for DA market makers are that the exchanges they work on are often unregulated, and operate with subpar technology that market makers rely on to execute orders efficiently. Since, these exchanges are often less than professional the counterparty risks of holding large sums of capital on these exchanges are uncommonly high. These unique risks require financial compensation, and market makers that ignore the above mentioned challenges can end in complete ruin. In many cases market makers require a monthly retainer from either an exchange or a token project to compensate for the additional risks they experience in the DA marketplace. In the business these market participants are known as Designated market makers (DMM).
This means that market making services in the DA arena can be expensive to employ, and even harder to maintain. Take some time to scroll down the list of exchanges aggregated on sites like coinmarketcap. Once you really take the time to dive even just below the surface, you can find countless trading pairs with little to zero trading activity.
Wrapping it all up, market makers are necessary fixtures in the DA marketplace, and without them general trading interest in crypto would come to a grinding halt. So when you see orders popping in and out of view on the order book, be aware that a market maker is on the premise.