Cryptocurrency liquidity is the lifeblood of efficient trading, fair price discovery, and the overall health and growth of the crypto market. However, not all digital assets are as liquid as popular Bitcoin. How is it possible to generate sufficient trading volume and liquidity for less popular assets? The answer is crypto market making. This article will explain who market makers are and how they work.Who is a Market Maker?
When you trade on a crypto exchange, you don’t reflect on who is there on the other side of the order. But what if there is no organic counterparty for your order? What if no one is willing to buy your tokens at your desired price? In this case, you have two options:
- on a low-liquidity market, you have to wait long until there is someone ready to execute your order;
- on high-liquidity markets, your order will be executed immediately, despite the market conditions.
Market makers stand behind quick and efficient order execution at a fair price. They are financial entities, specialized companies, or high-frequency traders that cooperate with a market-maker trading platform to supply liquidity to its markets.
A market maker is a market participant who places orders on buying and selling assets, and this order stays in an order book until someone wants to match it. So, a market maker stands always ready to fulfill emerging orders (from other traders) on a crypto exchange.
Here is what market makers do:
- Provide continuous liquidity by placing buy and sell orders.
- Narrow the bid-ask spread by offering competitive buy and sell prices.
- Facilitate the formation of fair and accurate market prices.
- Enable large transactions by absorbing large orders without significantly impacting the market price.
- Stabilize market volatility by dampening price fluctuations and creating a more stable market environment.
- Support new tokens, helping to kickstart trading activity and market interest.
Market Maker Strategies
Here are the most common cryptocurrency trading strategies that market makers use:
- Cross-exchange liquidity mirroring
- Two-legged trading
- Market making without hedge
- Delta neutral market making
- Grid trading.
Let’s drill down on a two-legged trading strategy. The idea of this strategy is to buy and sell tokens simultaneously. It involves opening two limit orders with different prices. A buy order price is set lower than the current market price, and a sell order price is higher than the market price. When these two orders are executed, a market maker profits from their price difference.
Market makers are crucial in providing liquidity and stability to the cryptocurrency market. Their strategies and techniques help to create a favorable trading environment for other market participants.