Understanding market makers, the invisible hand that drives the crypto market

 One of the most well-known but least understood cryptographic forces is the market maker. Project teams, exchanges, and project founders rely on them to provide liquidity and support trading. Market makers (MMs) are an asset to the industry, even if they sometimes get a bad reputation from those who misunderstand their role.Market makers are essentially tasked with providing buy and sell liquidity, allowing traders to acquire or dispose of tokens on demand, even for crypto-assets with low market capitalization, volume and liquidity. Without the presence of market makers to provide a liquidity buffer, the sale of small-cap tokens would suffer significant slippage. This article examines how market makers work to make the market more attractive to buyers and sellers.

What is a market maker?

 A market maker is an entity – usually a corporation – that uses the assets it holds to provide liquidity to certain financial markets. For this reason, they are also sometimes called liquidity providers (LPs). If you’ve ever provided liquidity to a decentralized exchange (DEX) such as Uniswap, you have direct experience with LPs. Market makers do this on a much larger scale, usually for centralized exchanges but sometimes for DEXs as well.Market makers work by setting a series of limit orders at different price points, known as buy and sell prices. They set orders for both assets on both sides of the trade, for example BTC and ETH. This ensures that buy and sell orders can be executed. Otherwise, a trader would have to wait for a willing counterparty to come online and agree to sell to them at the desired price level.A market maker typically sets reference prices for crypto-assets based on the price at which they trade on other exchanges. This ensures price consistency and reduces price dislocation, which leads to arbitrage. Essentially, MMs ensure that on the exchange or platform in question, a trader can reasonably expect to get a deal similar to what they would receive on any other comparable platform.

Making and taking

Traders who fill out market price quotes, called takers, generally pay higher exchange fees than makers. A maker is the trader who provides a price quote, i.e., posts an offer to buy or sell. Market makers ensure the ebb and flow of transactions between users, making sure there is always an offer to buy or sell so that orders can be executed almost instantly.From the perspective of exchanges, market makers play several useful roles. They promote consistent and reliable trading, which keeps users coming back and improves the trading experience. This then allows exchanges to collect more fees through increased volumes. Traders are inclined to trust an exchange that uses a reputable market maker more, as it ensures that the bid/ask spread is tighter, resulting in more stable token prices. Crypto markets can be volatile at the best of times. Markets that are illiquid or have large gaps between supply and demand levels exacerbate this volatility. By providing liquidity when and where it is needed, and at the price at which it is needed, market makers form the invisible hand that carries the crypto-currency market. They enable exchanges to operate reliably, regardless of market conditions or the market capitalization of the tokens being traded.