Understanding Market-Making in Crypto

Today's global cryptocurrency market cap is $2.58 Trillion, a 0.88% change in the last 24 hours and 107.92% one year ago, but don't let these numbers fool you; the market can expand and contract at a moment's notice, and traders need to be ready for any event.

While the total market capitalisation represents the value at current prices, the amount of funds currently trading is far smaller; this float of around 150 billion is traded daily, and that's how we get the prices aggregated from various exchanges.

The cryptocurrency market is a bustling place, but sometimes finding a buyer or seller for your digital assets can be tricky. That's where market makers come in, acting as the grease that keeps the wheels of crypto trading turning smoothly.

So, what exactly is market making in the crypto world?

In essence, market makers are the backbone of the cryptocurrency market, providing much-needed liquidity to exchanges.

Their constant buy and sell orders for various cryptocurrencies create a readily available pool of assets for traders, ensuring they can execute their trades quickly and efficiently.

This security and confidence in trading is all thanks to market makers.

Where does the market making magic happen?

Cryptocurrency exchanges are the primary battlegrounds for market makers. These online platforms connect buyers and sellers, and market makers set up shop within their order books.

The order book is a giant list showing the current buy and sell orders for different cryptocurrencies and their corresponding prices.

An exchange order book is the heart of how market makers and traders interact on a cryptocurrency exchange. It's essentially a giant list displayed in real-time, showcasing all the current buy and sell orders for a specific cryptocurrency.

Here's a breakdown of the order book:

• Buy Orders (Bids): These represent orders from traders who are willing to buy a certain cryptocurrency. The order book shows the price they're willing to pay (their bid) and the amount of cryptocurrency they want (volume). Bids are typically listed from highest price (most eager buyer) to lowest price.
• Sell Orders (Asks): These represent orders from traders who are willing to sell a certain cryptocurrency. The order book shows the price they're willing to sell at (their ask) and the amount of cryptocurrency they're offering (volume). Asks are typically listed from lowest price (most eager seller) to highest price.

Think of it like an auction board:

• Bids are like raised hands from people willing to buy, with the highest offers at the top.
• Asks are like the price tags sellers put on their items, with the lowest offers at the top.

Market makers use the order book to place their buy and sell orders strategically.

Market makers analyse the existing bids and ask where supply and demand lie. This helps them set prices for their own orders that are likely to get fulfilled quickly, contributing to overall market liquidity.

By constantly updating the order book with new buy and sell orders, traders and market makers together determine the current market price for a cryptocurrency. The price at which the highest bid meets the lowest ask typically reflects the current market value.

Market-making is a crucial component of financial markets, including the cryptocurrency market. It involves providing liquidity by continuously buying and selling assets to facilitate trading and maintain market stability. This article delves into the role of market makers in crypto, exploring their functions and the different models of market-making.

So why are market makers so important? Market makers play a crucial role in the crypto ecosystem by:

1. Boosting Liquidity: By constantly placing buy and sell orders, market makers ensure there are always enough willing counterparties for trades. This reduces waiting times and prevents price swings caused by a lack of buyers or sellers.
2. Price Stability: Market makers don't just place random orders. They use sophisticated algorithms and analysis to set prices that reflect the overall market sentiment. This helps maintain price stability and prevents wild fluctuations.
3. Attracting Traders: A well-oiled market with ample liquidity and stable prices is more attractive to traders. This increased participation further strengthens the market and benefits everyone involved.

Who Are Market Makers in Crypto?

Market makers in crypto are entities or individuals who provide liquidity to the cryptocurrency markets by placing buy and sell orders on various exchanges. There are two primary models of market-making in the cryptocurrency market: Designated and principal market-making:

Designated market makers

Designated market makers are appointed by an exchange to provide liquidity for specific assets. They have obligations to maintain bid-ask spreads within a certain range and ensure a minimum level of liquidity. Exchanges often incentivize designated market makers with lower trading fees, rebates, or other financial incentives to ensure they meet their liquidity commitments. An example is this market-making program: https://whitebit.com/market-making-program. The risk of such market makers is relatively lower as their activities are often subsidized by the exchange, and they follow predefined guidelines. In addition, their activities are transparent and more controlled.

Principal market makers

Principal market makers trade for their own account and take on the risk associated with buying and selling assets. They are not appointed by any exchange but choose to provide liquidity independently. Their profit comes from the spread between the buy and sell prices they offer. They have more freedom but also bear all the risks associated with their trading activities. The risk is higher due to the independent nature of their operations and the direct exposure to market fluctuations. Their activities are less transparent, however, they are more flexible.

Here is a comparison table to highlight the differences between the two models:

Table: Designated vs. Principal Market makers

Role of Crypto Market Makers

Crypto market making is essential for maintaining market stability and liquidity. Market makers help narrow the bid-ask spreads, which reduces trading costs for participants. They provide depth to the market, ensuring that large orders can be executed without significant price impact. By doing so, they foster a more efficient and accessible trading environment. 

Market makers also play a critical role during volatile market conditions. By continually placing buy and sell orders, they help absorb shocks and prevent extreme price swings. This activity is particularly crucial in the relatively nascent and often volatile markets.

Crypto market making is a fundamental basis that ensures the smooth operation of cryptocurrency exchanges.

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Recommended reading

If you enjoyed this post and have a little extra time to dive deeper down the rabbit hole, why not check out the following posts on cryptocurrency and blockchain?

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Disclaimer: This article should not be taken as, and is not intended to provide any investment advice and is for educational purposes only. As of the time of posting the writers may or may not have holdings in some of the coins or tokens they cover. Please conduct your own thorough research before investing in any cryptocurrency, as all investments contain risk.

Tags: Blockchain, Cryptocurrency, Trading, Guest Post