Today, market makers have become one of the key figures in the financial market. There is an opinion that they are able to change asset prices, but in fact this is certainly not the case. The main and main task of market makers is to provide liquidity for any assets. If an asset traded on the exchange does not need liquidity, then the price and spread will have an adequate level. But if there is no liquidity – then trading with this asset will stop, the price will stand at the same level, and the spread will begin to expand. What do market makers do in the market? We will try to analyze it in this article.
Market maker-translated from English as “market participant”. It can be a legal entity or an individual. A market maker enters into an agreement with exchanges to maintain price levels for traded assets. Who can market makers be? These may include a central or commercial bank, a large fund, a broker, or just a private investor. As a rule, they provide liquidity for a certain asset, in other words, the best BID and ASK prices for residents of the market. Market makers are divided into two types: institutional and speculative.
They can often act as an intermediary for the seller or buyer, if one of the parties is absent. For example, you decided to make a transaction on the stock exchange, sell or purchase an asset. In the event that the transaction was completed in a matter of seconds, you can be sure that the market maker acted as an intermediary. This is done in order to remove delays and any difficulties during the exchange of an asset.
How does the market maker trade work?
A person appears on the exchange, he wants to buy 100 ETH, on the other side there is a seller who sells 90 ETH. Here the market maker has a task to add 10 missing ETH to the seller. After that, he puts the price to the buyer, for example, $200, and to the seller, for example, $199. As a result, the buyer will purchase his assets in the amount of 100 ETH for $20,000, and the seller will earn $17,910 for 90 ETH. The profit of the market maker will be $2,000 for providing 10 ETH and $10 spread for the provided liquidity.
Thus, a market maker can make a lot of transactions per day and have a good income. Of course, in order to be able to turn all this around constantly, the liquidity provider must have a stock of assets in order to continue supporting the level between supply and demand. By such actions, market makers ensure efficiency in the financial market and maintain adequate asset prices.
This example may give the false impression that a market maker always earns a lot and is stable, just having good capital. But this is certainly not the case. Everyone knows that the crypto market can be highly volatile. So, in a time of such high market volatility, a liquidity provider will be able to incur significant losses in its capital. Let us take an example.
A person appears on the market again, he decides to buy 100 ETH, and on the other hand there is a seller who puts up 10,000 ETH for sale. When the transaction takes place, the remaining 9,900 ETH must be redeemed by the market maker. And as it is easy to guess, it will not be possible to recapture the entire amount from him.
In this regard, many liquidity providers leave the market during strong volatility. This is again due to the fact that they can suffer serious losses of personal funds. Therefore, if you are unable to close a position due to lack of liquidity, this may mean one thing – the market maker has left the market.
If you want to check whether the market maker is participating in the auction, you can look at the spread and the price of the asset. In the case when the spread is narrow, and the asset price is in the sideways direction, we can conclude that the liquidity provider is in place. If the spread is wide, and asset prices are extremely volatile, market makers have withdrawn from trading.
At the same time, the exchange situation is analyzed not in the usual horizontal version for a trader, but in the vertical one. Liquidity providers also have access to the order glass, where they can see asset purchases and sales, as well as a list of pending orders, take profits and stop losses. This gives them an advantage in correctly understanding the market mood, as well as fulfilling their obligations well – to supply liquidity and a narrow spread.
A market maker in the Crypto Industry
In the crypto industry, the work of a market maker is much more in demand than in the traditional one. This conclusion can be made if you look at the top ten popular cryptocurrencies. Their liquidity is always provided and if you decide to buy or sell one of these coins, the operation will happen in a few seconds. But if you look at less popular coins, there is almost no liquidity there.
How does the process work?
The new project plans to hold an IEO. Exchanges consider the coin and list it. After a certain period of time, investments in it become minimal. There are two reasons why this happens.
- An experienced trader, before investing in a new coin, even if it seems promising to him, will first study the order book. And if there are no records of sales and purchases in it, the trader will not invest his funds in it.
- Some large investor learns about the listing of a new coin, he likes the future prospects and decides to open a large and long-term position. But then it turns out that there is no liquidity, which means that even if a position is opened, the investor will lose quite a lot of time for this.
It is in order to avoid such cases that the crypto market resorts to the services of market makers.
What strategies are used by market makers
- Often, market makers use ATC and HTF trading. In order to use these systems, you will need excellent programming skills. You will also need to know the economic component of the market: this is necessary in order to correctly assess the work and risk.
- Sell-Side is an automatic trading system that constantly maintains the optimal price and extracts profit from the spread.
- HTF trading is a kind of algorithmic trading. The key difference is the high speed and capital turnover. In order to be an HTF trader, specialized robots and powerful PCs will be useful, since the task of this kind of trading is to conclude a large number of transactions in a short time.
Myths about market makers
On the Internet, you can find entire articles with myths that relate to market makers. Let’s analyze some of them.
A market maker can influence market quotes
This is partly true. As we remember, one of the tasks of a market maker is to create a market mood and provoke participants to open orders in the right direction. The market maker will not be able to directly influence the price for two reasons.
- Exchanges closely monitor their market maker’s every move, and if they see a deliberate impact on the asset’s price, the consequences will be immediate.
- For that kind of activity, no one’s gonna pat you on the head because it’s a trade manipulation. In other words, government regulators will have to be dealt with, and they may in turn leave the market maker unlicensed.
Market makers cooperate with each other
I would like to remind you that all market makers are competitors. And who in their right mind would divulge their plans to a competitor? In addition, it is illegal and, again, it may result in the revocation of the licence to operate.
So who are the market makers? They’re a necessary part of the economy. The Market Maker does not earn on price movement, but creates comfortable conditions for market participants.
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