What is a Market Maker?

A market maker, or “liquidity provider”, is a company or an individual that offers to buy and sell a financial instrument or commodity they own at a fixed price.

This helps ensure availability of a commodity to trade, as well as a reliable price in a volatile market. The reason for doing this is to stimulate activity and interest across the broader market as traders tend to avoid an illiquid (non-active) asset for fear they won’t be able to exit a position.

As Investopedia puts it:

“In short, market making facilitates a smoother flow of financial markets by making it easier for investors and traders to buy and sell. Without market making, there may be insufficient transactions and less overall investment activities.”

Market making is a common practice in the capital markets such as stocks or bonds, and while there are some fundamental similarities to the general concept, crypto market making quickly became a very dynamic industry with some specific use cases we’ll cover below.

Market Making for Crypto

Nowadays, market making is commonly done by automated trading software or algorithmic trading tools that rely on real-time market data and pre-set business and strategic logic. This is especially true for crypto, which as a tradable asset also benefits from market making.

Cryptocurrencies often face a similar set of challenges:

• Low volume (i.e. little trading). Altcoins have little organic trading volume. ​This is why they are heavily impacted during bear and bull markets.
• Low liquidity (i.e. low depth of the market).
• Large price fluctuations and lack of interest from domestic and foreign institutional investors.
• Exchanges, such as Huobi and OKex, will delist projects due to a lack of volume.
• Whales impact the market by dumping tokens, dramatically lowering prices.
• A large gap between bid-ask prices on exchanges resulting in slippage when trading.

These issues can often be alleviated through market making by:

• Stabilizing spreads: Buy and sell prices are stable with market makers because they are buying and selling tokens at prices that the dealers have set at the time, meaning they are not directly affected by supply and demand changes.
• Supporting milestone events: Events such as ICOs or major press coverage often see an uptick in trade volume, which in turn require liquidity to ensure demand can be met.
• Providing visibility to crypto exchanges: Coins with high liquidity and more organic trading have a higher chance of being featured and approved when applying for a listing in certain exchanges.
• Attracting investors: Tokens with high trading volume and liquidity often attract more sophisticated investors.
• Staking: Facilitating supply for traders to hold coins for a period of time in return for rewards (we’ll be covering this in greater depth in an upcoming article).

At the end of the day, market making providers are filling in an important liquidity gap in a fast growing industry and helping new crypto markets enter the space. Having a market maker during the IEO stage of a new token became crucial to the success of a project, on top of bringing authority and business credibility to a young and constantly changing industry.