Who are crypto market makers and how do they work?

A market maker is an entity or individual within financial markets who directly buys and sells securities to facilitate other market participants’ transactions.

They set bid and ask prices for assets, thereby injecting liquidity and enhancing the market’s overall depth. This article explains market making in crypto: who can take this role and what impact they have.

Who is a market maker?

A crypto market maker plays a crucial role in the digital asset economy, ensuring liquidity and smoother price movements in cryptocurrency markets. These can be individuals or entities with expertise in financial markets and algorithmic solutions known as bots. Here is their description:

  • Individual market makers consist of experienced traders and institutions armed with specialized licenses. They aim to facilitate market liquidity while taking profit from transaction spreads. These market participants use rapid trading strategies, often concluding transactions within minutes. 
  • Algorithmic market making in crypto is the technological advancement in trading. Bots operate on Decentralized Exchange Protocols (DEXs) that utilize math algorithms to determine asset prices. This automation eliminates the necessity for human work, increasing efficiency and opening up additional profit opportunities like yield farming for investors. Despite their speed and efficiency, bots face challenges in volatility, where their lack of human intuition can lead to financial losses.

How do market makers work?

Crypto exchange market making implies continuous provision of buy (bid) and sell (ask) prices for specific cryptocurrencies. A crypto liquidity provider maintains a ready-to-sell inventory of these digital assets, facilitating immediate transactions for other participants who wish to buy or sell at market prices. This ability to instantly match orders makes it easier for other traders to execute their trades with minimal price difference.

The essence of a market maker’s operation lies in the spread – the difference between the buy and sell prices they offer. For instance, if a market maker posts a buy price for one token at $19,500 and a sell price at $19,550, the $50 difference represents the market maker’s potential profit margin for facilitating this trade. By capitalizing on this spread across numerous transactions, market makers can generate large profits.

Market makers in crypto exchanges provide certain liquidity levels in their trading platforms and receive reduced trading fees and other incentives in return.

How do crypto market makers make money?

Capitalizing from the bid-ask spread is the main crypto market maker strategy. However, they also enjoy reduced operational costs and lower fees on exchanges due to their valuable role:

  • Spread. Market makers capitalize on spread by simultaneously offering to buy and sell cryptos, thus profiting from the price discrepancy. 
  • Reduced fees. Due to the benefits of crypto market making services, many crypto exchanges offer them reduced trading fees. This incentive encourages market makers to operate on these platforms and significantly lowers their business costs. Some platforms charge zero maker fees.
  • Volume-based rebates. Some exchanges implement a fee structure that rewards market makers with rebates based on the volume of trades they facilitate. This model enhances market makers’ profitability, as their active participation in the market directly impacts reduced costs and higher earnings.
  • Arbitrage. Market makers often engage in arbitrage, taking advantage of price differences for the same asset across different exchanges. By buying crypto at a lower price on one exchange and selling it at a higher price on another, makers extract profit from the price difference.

What’s the market maker’s impact?

Market makers are often called manipulators because of a misconception associated with their activity. Indeed, some bad actors promise unrealistic price targets or trading volumes to project owners and exchanges. Given the less regulated nature of the crypto space, these manipulative practices may go unchecked, ultimately harming the market’s integrity over time.

But beyond these unethical examples, what is the role of a genuine market maker in crypto? The primary function is not to manipulate but to facilitate trading by providing liquidity and stability to the crypto markets. They achieve this by always being ready to buy or sell cryptocurrencies, ensuring that trades can be executed even in the absence of a direct counterpart.

Moreover, cryptocurrency market making contributes to the discovery of fair prices by balancing buy and sell orders, which reflects the market’s true supply and demand dynamics. This role is critical, especially in the highly volatile crypto market, as it helps reduce price swings and ensures a smoother trading experience.

By enhancing liquidity, market makers enable small and large traders to enter or exit positions without changing the asset’s rate. It fosters confidence among market participants, encouraging further investment and participation.

Market makers’ contribution is essential for the growth and maturity of the cryptocurrency market. It helps the market remain accessible and functional for traders of all sizes.