It’s easy to take for granted how fast and efficiently you can place a trade today. But remember that whenever an asset is bought or sold, there must be somebody on the other side of that transaction.
Enter Market Makers, facilitators of liquidity for a digital asset and a key enabler for a successful crypto project.
In this article, we will explore the role of market makers and how they facilitate the movement in the crypto market.
What is a Market Maker?
Market makers are individuals or firms that facilitate sales between two parties, and ensure that there are both buyers and sellers of specific securities in the market at any given time.
A market maker is a firm or individual that stands ready to buy or sell a security. Investors may take the ability to buy and sell securities whenever they want for granted. Remember that every time you buy or sell an investment, there's another party on the other end of that trade. That party is often a market maker.
The market maker will offer up-to-date prices at which they're willing to buy or sell and the amounts of the security it's willing to buy or sell at those prices.
Other than the fundamentals of the project, a project’s token price is also largely affected by the supply and demand of the token on a given exchange. The demand for a token can be translated to the bid (price to buy), while the supply for the token can be translated as the ask (price to sell).
A healthy trading environment for a token should allow for bids and ask orders to be filled quickly without much price discrepancy from the traded price. The following factors are the main components that contribute to a healthy market for tokens.
A token has healthy liquidity when a seller can quickly find a buyer or vice versa, without having a huge price difference for the token. The sellers do not need to cut their prices and the buyers will not have to pay an increased amount to secure the token they want.
Without liquidity, large buy or sell orders can potentially cause a drastic price movement in the market. This makes the price of the token highly volatile and might deter investors from entering the market. Market makers can enter at such points to provide the necessary liquidity to help stabilize the token price in such liquidity crunch events.
2. Bid-Ask spread
For the transaction to be carried out, there has to be an agreement on the offered buyer price and the offered seller price. The difference between the highest bid price and the lowest ask price is known as the bid-ask spread.
Generally, a narrow bid-spread is favored as it represents a healthy market with steady flow of transactions. Market Makers can create that impression of immediacy by buying and selling large amounts of a particular token in order to not leave any buyers or sellers hanging in the market. This ensures the smooth running of financial markets which can attract speculators and investors to the market, adding to the favorable market conditions.
3. Depth of Order Books
An order book lists the number of shares being bid on or offered at each price point, or market depth. This consolidated information serves as a tool to visualise a real-time list of outstanding orders for a particular token and represent the interests of buyers and sellers.
This gives sophisticated investors a glimpse into supply and demand depth while exposing any order imbalances and resistance zones. Market makers can help to promote a healthy order book by ironing out order imbalances and providing depth to both supply and demand sides.
Why are market makers important?
- Maintain liquidity in the market
Market makers are important because they help to maintain liquidity in the market. By posting buy and sell orders for various cryptocurrencies on exchanges, this helps to create liquidity in the market and enables traders to buy and sell cryptocurrencies more easily. They actively place orders for earning profits, reducing the spread, and maintaining liquidity.
Liquid markets are characterized by big spreads. If there are no market makers, the markets will become less active and it would be much harder for traders to buy and sell cryptocurrencies, as there may not be enough liquidity in the market. This could lead to wider spreads between the bid and ask prices, making it more difficult and costly for traders to enter and exit positions.
- Reduce market volatility
In addition to providing liquidity, market makers also help to reduce volatility in the market. By constantly posting buy and sell orders, they help to absorb fluctuations in demand and supply, which can help to smooth out price movements. This is especially important in the crypto market, which is known for its high volatility.
For example, let's say that there is a sudden surge in demand for a particular cryptocurrency. Without a market maker, this demand could cause the price of the cryptocurrency to skyrocket, as there may not be enough supply to meet the demand. However, if a market maker is active in the market, they can help to absorb some of this demand by selling the cryptocurrency to buyers. This can help to reduce the price increase and prevent the market from becoming too volatile.
Having designated market makers on exchanges is more important than ever as market structure continues to change.
How do market makers profit?
Market makers make money by charging a small fee for their services. This fee is known as the "spread," and it is the difference between the bid and ask price of an asset. For example, if the bid price for a cryptocurrency is $100 and the ask price is $105, the spread is $5. Market makers earn this spread as a profit for facilitating the trade.
In addition to earning the spread, market makers may also profit from the difference between the price at which they buy an asset and the price at which they sell it. This is known as the "arbitrage" profit. For example, if a market maker buys a cryptocurrency for $100 and then sells it for $110, they would earn a $10 arbitrage profit.
What are the benefits of partnering with a market maker?
By partnering with an established and credible market maker who provides liquidity on pre-agreed terms, token companies can potentially expect the following benefits:
- Higher liquidity: by having enough liquidity available in the token, investors and founders can invest or liquidate their positions more easily
- Higher trading volume: higher liquidity potentially attracts more interest and trading in the token due to lower transaction costs and market impact
- Lower probability of price manipulation: higher liquidity makes it more difficult to manipulate the price of a token since more capital is needed to move prices
- Higher interest in the token project: more people trading in the token and possible listing on bigger exchanges create more interest and discussion around the token project
- Easier listing on major crypto exchanges: more reputable crypto exchanges are more likely to list a token on their platform knowing that there is a market maker committed in providing liquidity 24/7
When should Web3 projects approach market makers?
Most market makers have deep knowledge of the market and strong connections with centralized crypto exchanges. For new projects that have not listed their tokens yet, it is worth exploring the opportunities that market makers can provide in terms of listing help. Therefore, projects that have not listed their tokens yet could connect with top exchanges through their market maker of choice.
In other cases, projects that are already listed might want to expand their listing to more exchanges. Market makers can help to provide liquidity by acquiring tokens via OTC transactions and open new doors for the tokens to be listed.