changehero Blog

Beginner's Guide to Crypto Market Makers
Author: Alexander
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Without deep liquidity and high volume, crypto markets wouldn’t have grown as big as they did. What role do crypto market makers play and can we do without them? The short answer is, probably not. As for the longer answer, read this guide from the ChangeHero team.

Key Takeaways

What are Crypto Market Makers?

Before we dive into details, it will be useful to settle on a definition of a market maker. A crypto market maker is an individual or entity that provides liquidity to a digital asset by buying and selling it on a trading platform.

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Liquidity, in turn, is a quality that determines how easily an asset can be bought or sold. Market makers set offer and bid prices for trading pairs, ensuring a high level of trading activity and attractive environments for trading. They do it by maintaining buy and sell orders in the same asset, filling the opposite trade as soon as another market participant fills one of their orders.

Traditional financial markets and Crypto

Market makers in traditional financial markets provide liquidity to assets such as stocks, bonds, and commodities. Some stock exchanges have so-called designated market makers: singular entities with a monopoly on the order flow. All in all, traditionally, market makers set the pace for the rest of the market participants.

Crypto market makers are largely occupied with the same activities but also face unique challenges, including high volatility and limited regulatory oversight. Despite these differences, crypto market makers employ similar strategies to traditional market makers, including algorithmic trading and risk management.

The Importance of Market Makers

Providing Liquidity

Without a committed entity like a market maker, there could be a market in a digital asset but one with low liquidity. Individual traders can only do so much to create depth in a market. Having a market maker trade a certain amount of the asset on both sides of the market helps ensure trading is efficient and balanced.

The goal of market making is not to create liquidity itself: these market participants are in the game for profit. Rather, liquidity is the side effect of market makers competing to fill orders and profit from the bid-ask spread. Nevertheless, everyone wins from having more activity in the market.

Price Stability vs. Arbitrage

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Market maker services benefit from keeping price discrepancies low, mitigating arbitrage opportunities even between different exchanges. While some traders might want to have more of those, in general, keeping market prices fair and reflective of market conditions benefits a larger share of market participants. A liquid market is also less prone to significant slippage, although, after a certain point, it can become somewhat volatile.

Facilitating token adoption and growth

A major hurdle in the cryptocurrency market and digital assets has been its relative illiquidity. Market makers help facilitate token adoption and growth by providing liquidity and enabling traders to buy and sell digital assets.

Moreover, liquidity providers contribute to the stability of the cryptocurrency markets by ensuring price continuity and a relatively narrow bid-ask spread. Market makers enable assets with traditionally low liquidity to be traded more frequently, increasing their market visibility and attractiveness to investors.

How Do Market Makers Profit?

Bid-Ask Spread Management

Market makers generate income by charging a spread on the buying and selling price of assets in financial markets. They profit from the difference between bid and ask prices, with a wider spread translating to higher profits. However, as we have mentioned, they must keep a balance between making a profit from this spread and filling as many orders as they can.

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Market makers in crypto, much like on stock exchanges, charge a general fee for their services. Although they provide liquidity and keep a market active, they take certain risks holding an asset while trying to sell it. To cover it, cryptocurrency exchanges compensate them.

Capturing spreads and arbitrage opportunities

Another way for market makers to make money is to capture spreads and arbitrage opportunities. By doing so, they also provide liquidity and reduce price discrepancies between different exchanges. They employ advanced algorithmic trading strategies, continuously monitor market conditions, and adjust their approach to identify and capture these opportunities.

Market-Making Strategies and Techniques

Managing inventory and Hedging Risks

Market makers manage their inventory of digital assets to maintain profitability. To this end, they employ risk management strategies such as hedging and diversification.

While diversification means acquiring a varied asset portfolio to capitalize on price volatility in different markets or reduce losses, hedging is usually done in the same market with an opposite position. In our guide on investing $100 in BTC in 2023, we have shown how a diverse crypto portfolio performed better than Bitcoin — read it if you are curious.

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How does hedging work? It usually involves derivative assets, such as option contracts. If you go long on a crypto asset but would like to insure yourself against losses if the price goes down, you can get a put option, limiting your potential loss to the premium.

Interacting with exchanges and other market participants

Obviously enough, market-making does not happen in a vacuum. Participants have to be aware of the market dynamics and interact with exchanges and other market participants to provide liquidity and optimize trading conditions.

Efficient market makers work with exchanges to provide market data and help maintain market liquidity for a fee for their services. Outside of the market’s bounds, they collaborate with other market participants to share knowledge and best practices.

Optimizing liquidity provision and management

Last but not least, market makers optimize liquidity provision through order book management and inventory control. We have mentioned the latter but what about the former?

Order books on crypto exchanges are largely the same as on a stock exchange: a list of buying and selling prices (bid and ask). In the digital era, most trades are executed automatically at the best price but market makers retain some extra leverage. For example, they can connect buyers and sellers at their bid-ask spread if they provide better trade execution than the market at the moment can offer.

Evaluating Market Makers

What makes a crypto market maker successful and effective? A few things: reputation and compliance, service quality, and cost-effectiveness.

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Even in crypto, market makers should comply with relevant regulatory requirements and maintain a strong reputation. They should be transparent about their business practices and regulatory compliance, adhere to fair business practices, and avoid conflicts of interest.

Market makers should provide high-quality services and adhere to strong business ethics. Usually, it translates to prioritizing the needs of their clients and maintaining a strong reputation. It also helps if they are transparent about their services and fees.

And speaking of fees, ideally, they should have cost-effective services and competitive pricing. Undercharging will leave a market maker eventually unable to render their services. Overcharging is a cost imposed on the trading platforms, which they can and will eliminate if it is not worth the value.

The Difference Between Crypto and Traditional Market Makers

Unique challenges and opportunities in crypto markets

Crypto market makers face unique challenges, including high volatility and limited regulatory oversight. As you would imagine, in financial markets, this occupation is under scrutiny but much less so for the crypto market makers.

Crypto market makers also enjoy extra opportunities, including the growth of DeFi and the increasing adoption of crypto assets. A worthy price for the more challenging market conditions inherent to this market!

Adapting traditional market-making strategies

Crypto market makers are adapting traditional market-making strategies to the unique challenges and opportunities inherent to crypto markets. The new strategies and technologies find application in algorithmic trading and especially decentralized finance, a new ground for liquidity providers.

Evolution of market making in response to crypto’s growth

Market making is evolving in response to the growth of crypto markets, incorporating new strategies and technologies. The need to manage both off- and on-chain trades necessitated innovations such as bridging, which shakes up liquidity management. Automatic market makers were also pioneered in crypto and DeFi to a resounding success.

The Role of Market Making in Crypto’s Future

By now, you probably already understand how crypto market making improves the trading experience and the markets themselves. To further reiterate, it captures the emerging trends and innovations in market-making, transforms it under the influence of DeFi, and presents unique challenges and opportunities.

In addition to DeFi, another technological advancement that is finding its way into market-making is artificial intelligence. While it is a whole other can of worms from digital assets, crypto market makers seem to be particularly fond of the idea.

In 2024, when crypto-backed derivatives such as Bitcoin ETF see even more adoption, institutional market makers pick up digital assets even more willingly than before.

Conclusion

Market makers play a crucial role in maintaining liquidity in crypto markets, making them attractive environments for trading. They enable traders to buy and sell digital assets quickly and efficiently. Market makers contribute to the stability of the cryptocurrency markets by ensuring price continuity and a relatively narrow bid-ask spread.

More guides and updates from ChangeHero are posted on our blog, so definitely check them out! To get market insights and crypto news as they happen, follow us on social media: X, Facebook, Reddit, and Telegram.


Frequently Asked Questions

Who are the largest market makers in crypto?

In the cryptocurrency market, some of the most well-known market makers are Wintermute, GSR Markets, Jump Trading, and Cumberland.

What is a market maker for crypto?

In cryptocurrency markets, market makers do the same as in traditional ones: provide buy and sell orders for other traders. By doing so, they enhance market liquidity and enable a more efficient market.

What does a market maker do?

In finance and crypto, market makers provide liquidity by publishing buying and selling orders with specific bid-ask spreads. This way, market participants enjoy a more active trading environment and market makers profit from offering attractive bids and asks.

How much do crypto market makers make?

According to RocketReach, Jump Trading makes $360 million yearly and Citadel Securities made $377 million in 2024.

What is the difference between a market maker and an exchange in crypto?

Crypto exchanges are trading platforms where anyone can trade digital assets. Crypto market makers, on the other hand, are market participants who commit to trade toward both sides of the cryptocurrency market (in a two-way market).