Market making is an indispensable but misunderstood sector of the crypto industry. I would like to share a few details about crypto market makers.
What do market makers do
Market makers, also known as liquidity providers, play a fundamental role in asset markets by simultaneously quoting bid (buy) and ask (sell) prices for assets on an exchange. By quoting prices at which they stand ready to buy and sell assets, they facilitate price discovery and liquid trading by other market participants. In addition, by quoting prices on different trading venues and arbitraging away inter-market dislocations across different markets, market makers increase overall market efficiency.
Market making in crypto markets
Digital asset markets lowers the barriers to entry that impede the general public from market making in traditional financial markets. In particular, individual traders have direct market access to digital asset exchanges, enabling them to provide price quotes and execute trades programmatically using the same APIs as professional firms. Digital asset exchanges also provide market data feeds free of charge.
While certain exchanges provide volume-based fee rebates that favor professional trading firms, they generally do not offer co-location or other features that provide significant competitive advantages to large players at the expense of smaller ones. In fact, the location of servers hosting a digital asset exchange is typically a tightly kept secret. In addition, since the digital asset exchange landscape is highly competitive with hundreds of active, globally accessible venues, exchanges who introduce anti-competitive features risk losing business from individual traders and small firms.
Yet despite the lowering of competitive barriers to market making, there remains relatively few market maker compared to the proliferation of digital assets and exchanges, leading to the extreme concentration in liquidity. Market makers for digital assets, primarily quantitative hedge funds and trading firms, are in high demand, evidenced by the compensation they receive from both exchanges and token issuers.
Why do you need market makers?
Market makers create important benefits to token projects and exchanges. First and foremost, market makers enable liquid trading so that buyers and sellers can readily buy and sell the asset at reasonable prices while minimizing the friction costs of transacting. In other words, market makers aim to help maintain a healthy order book with tight bid/ask spreads. Healthy order books minimize volatility and increase the stability of the token price.
In today’s fragmented crypto market, a $100k block trade of a top-50 coin could possibly result in a trader losing 10% due to slippage, the difference between the observed market price and the actual execution price. Lack of liquidity can also increase the risk of a flash crash, which occurs when a large market sell order clears out all the top buy offers in the order book and instantaneously moves the price downward substantially.
In order to improve token liquidity, most token projects, particularly those listed on the major exchanges, and newly launched or long-tail exchanges choose to hire professional market makers, while established exchanges will also incentivize market makers by providing low trading fees and even rebates.
Market makers exist in all markets even beyond the crypto space. Most merchants are actually a market maker because they trade the spread.
Cheers.
_some info gotten from: hummingbot.io_
This post was made by special request from @Koush .
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