Market Makers: Who, What, and Why?

#29. Cryptocurrencies and Blockchain

Market Makers: Who, What, and Why?

Who is a market maker? Market makers can be both legal entities (banks, funds) and individuals (big brokers, major players). Specifically, we’re looking at the securities market, Forex, and cryptocurrencies. What is the purpose of MMs in trading?

Who Are Cryptocurrency Market Makers?

Market makers belong to a special category of market participants who act as intermediaries between sellers and buyers. Having large asset stocks, MMs contract with trading venues to maintain market liquidity.

In the crypto market, liquidity means the ability of a certain digital currency to convert freely into other cryptocurrencies. Slight price fluctuations of digital coins indicate market stability and mean high liquidity. When liquidity is low, the market is unstable, and prices spike.

What does a market maker do? The essence of their work is to bring the difference between supply and demand to the minimum values. MMs react to rises and falls (downtrend and uptrend) by going against the market trend. The market maker buys when everyone else is selling and sells when everyone else is buying. This is one of the mechanisms supporting market liquidity.

There are two types of market makers in the stock and forex markets: institutional and speculative. They differ in their influence on the market. The same situation is observed in the crypto market.

An institutional market maker is an organization that maintains prices and the balance between supply and demand under an agreement with the exchange.

A speculative market maker is a large participant capable of provoking a sharp movement in value through large volumes of traded assets.

Who Are Cryptocurrency Market Makers?

The Role of Market Makers in the Cryptocurrency Market

The importance of market makers in the cryptocurrency market is considerable. They fine-tune the market mechanism, ensuring its efficiency and reliability.

Key functions of market makers: 

  • Providing liquidity. 

The rate of some trading pairs changes in decimal fractions. It means that to make a real profit, you need solid capital. Not all traders have enough money to provide the necessary liquidity. As an intermediary, the market maker helps overcome the lack of liquidity and ensures that every trader has access to trading.

  • Matching and executing orders. 

The market maker’s job is to find a buyer and a seller for a certain volume of a certain currency pair. Then, the orders should be matched in the same currency pair and in the same volume for buying and selling. It can be problematic when there is no exact match of the orders. The market maker then becomes an intermediary trader or a buyer-seller. Thus, the market works without delays in the execution of orders.

  • Providing market depth. 

Market makers leave many buy and sell orders at a fixed price (limit orders). Next, they wait for traders to submit the corresponding orders. MMs’ limit orders create market depth and guarantee to sell a specific cryptocurrency promptly without affecting its price. For traders with large capital placing large orders, this is highly critical. If the market is deep enough, the execution of such orders proceeds without price spikes. Therefore, it is good for the market when there are a lot of market makers. In this case, one MM can stop work without affecting liquidity. 

  • Stabilization of spreads. 

The exchange needs a stable, low spread level. It will not be possible to maintain it without market makers. Market makers solve the problem by holding the necessary level of prices for traders. Thanks to these actions, the spread is fixed and kept narrow. This is beneficial for traders as transaction costs are reduced. 

So now we know why the market needs the market makers. Obviously, without MMs, the market would not be stable and accessible for ordinary traders.