Traders will point at volatile market events and claim the price was artificially manipulated, pointing the blame at market makers in crypto. Often, the data will point to market makers, who are seen moving vast sums on the blockchain just before big price moves and shifts in market direction. Price anomalies such as rapid crashes or pumps, price gaps, or widening spreads, may be the signature of market makers. In the crypto space, market makers are always present and are sometimes more influential than whales. The role of market makers may be indispensable, although sometimes, their actions go against the expectations of retail traders and look like a force of chaos on the market. What is a market maker — really? The role of a market maker has strict technical parameters when it comes to trading. Their main role is to ensure cryptocurrency markets have predictable liquidity by maintaining continuous buy and sell orders. In the absence of market makers, cryptocurrency trading would require the matching of orders at exact price points, making trading highly inefficient. The market maker determines the spread by setting its buy and sell orders. The spread, or the difference between bid and ask prices, allows the market maker to make a profit by selling at a higher price and buying at a lower price. Usually, market makers tend to keep smaller spreads to make markets more efficient. Market makers often receive complaints for swinging the market in one direction. There have been cases where a market maker provides orders only on the sell side of an asset, leading to a price crash. However, in the general case, market makers are risk-neutral. Unlike hedge funds or derivative traders, market makers do not make a bet on the direction of the market and instead rely on the bid-ask spread for their earnings. Market makers are also closely tracking their token and stablecoin inventories, using previously tested models to test their trades and strategies. They are careful to price their quotes slightly off true market value, then readjust their bid and ask prices as the market moves. They must ensure this happens smoothly, to avoid glitches, trading errors, or erratic price moves. Regular traders can adopt different strategies, with no demand for specific liquidity. Traders aim for their preferred price and may make more random choices. They also usually make directional bets on a price. The role of market makers is to absorb the moves of traders. Market makers also providing liquidity to the market through properly deployed inventory. They are not speculating on a direction, as they try to provide balanced liquidity. Why crypto markets need market makers more than TradFi Crypto markets are fundamentally different when compared to traditional exchanges. The markets have no settlement times and trade 24/7, with global access. Exchanges are fragmented and have vastly different trader pools. Crypto markets also often list new coins and tokens, leading to extreme volatility. All listed assets are directly available for retail trading, making liquidity and order books even more unpredictable. As a result, crypto markets are not established enough to build liquidity. Instead, steady liquidity conditions must be provided externally and engineered by market makers. How market makers actually make money Market makers have an incentive to provide liquidity, ensuring they will make money from their spreads. Spread capture is the placement of slightly different ask and bid prices, meaning the market maker buys slightly lower and sells slightly higher. The spread between the positions is taken as a fee for the market maker. Due to their high volumes, market makers usually have a fee discount or owe no trading fees to the exchange. Market maker trades usually pay lower fees compared to market takers, which only absorb existing orders. Market makers also build their own trading systems for low latency. Some market makers, alongside providing liquidity, are also building low-latency trading infrastructure, expanding the tools available to their native operations, as well as to other market makers. Market makers are often active on multiple trading venues, including centralized and decentralized exchanges. Some market makers can also make use of their trading tools to capture arbitrage opportunities or price inefficiencies between exchanges. Again, professional market makers rely on strict authority management and low-latency trading to achieve those goals. Achieving earnings also requires that the market maker is ready to generate high-volume trading. The spreads only offer thin margins, meaning the market maker may only make relatively small gains. The market maker must also track its inventory to propose optimal orders and spreads. The relationship between exchanges and market makers Exchanges and market makers have a symbiotic relationship. Exchanges offer the underlying platform, while market makers supply liquidity. For that reason, exchanges often offer incentive tiers based on trading fees. Market maker fees are always lower compared to market takers. Exchanges also offer special liquidity provision periods with special incentives. Binance has a native Liquidity Program with lower or zero fees. Market makers may also earn rebates and gain access to performance reports and statistics. Market makers also receive low-latency access for more efficient trading. Coinbase has a similar liquidity program that offers additional benefits to large-scale market makers. Exchanges will often offer preferential conditions to professional liquidity providers. Market makers are numerous and vary in size, but a handful of professional liquidity providers are usually selected for key market pairs. Some new listings often depend on market makers, who receive token allocations and provide two-sided liquidity. Exchanges are also careful to keep track of the best liquidity providers to avoid rogue traders, who can crash the market with one-sided liquidity. Centralized vs decentralized market making Market makers can operate through centralized exchanges, as well as through the decentralized trading (DEX) ecosystem. On centralized exchanges, market makers use the order book technology to place their orders. On DEXs, market makers can deposit passive liquidity, usually stablecoins, or two-sided liquidity. They will earn yield on their passive liquidity, though they will face the risk of impermanent loss. Market makers can also actively trade and place orders, benefiting from a more aggressive strategy and from taking profit on the spreads. DEXs did not eliminate market makers, but changed the possibilities and tools for providing liquidity. Market makers are often the first participants to join newly launched token pools, often through partnerships with the teams. When market makers pull liquidity — and why it matters Market makers are an everyday presence, but traders notice them during dramatic market events. Volatility spikes are common in crypto markets. Market makers can exacerbate the problem of volatility by pulling their liquidity. As already discussed, market makers are trying to make money while avoiding losses. Volatility spikes put the market maker at risk of losing the underlying assets. For instance, Wintermute has algorithmic protections, which adjust quotes based on inventory levels and market volatility. News shocks or risky trading can happen quickly, triggering the market maker algorithms. This may cause correlated risk-off behavior, shutting down positions in multiple markets. Market makers will reduce inventory exposure across multiple positions during periods of market stress. This will often lead to a breakdown of multiple assets, with no other correlation between them. For traders, this market-making activity translates into flash crashes, which may cause anomalous pricing far out of the usual trading range. In the case of total liquidity withdrawal, assets can fall to zero before recovering based on the remaining orders. Market makers can also cause a spread ‘blowout’, widening their usually tight bid-ask differences. Market makers will deliberately increase their bid-ask spread to protect themselves from significant losses. This also means traders will not see their orders filled as expected. Are market makers manipulating prices? The activity of market makers may necessarily lead to deep and anomalous market crashes. Often, traders will accuse market makers of deliberately crashing the price and exacerbating volatile price moves. Manipulation implies intent, which is not yet proven for market makers. Normal market reactions and algorithmic triggering can resemble deliberate one-sided price moves. Rarely, some market makers may offer one-sided liquidity, leading to a crash. Yet during usual trading market conditions, market makers react to news and are not interested in causing big directional price moves. Market makers receive incentives from exchanges, but they are not interested in causing directional moves. The incentives do not stand for intent. While some whales may act in a directional manner, exchanges tend to curate market makers and expect their behavior to stabilize the market. Binance, for instance, will remove rogue market makers who fail to provide stability. Narratives come from all kinds of sources and may cause trader reactions. Market maker activities at that moment may be misunderstood, as the algorithms to protect inventory are not always transparent. How market makers shape price discovery Market makers have to keep track of their inventory under varying market conditions. Reference prices are one of the ways to determine the market range. Those prices are set by a formula and are the basis for DEX activity . The formula determines the price based on the availability of tokens on each side of the trading pair. If more tokens are deposited, the price will drop. Conversely, if more stablecoins are available, the price can rise. This reference price moves on a curve, though some exchanges offer concentrated liquidity at a predetermined, narrower price range. Market makers are given low-latency access and track multiple markets. This allows them to make trades that shift the prices to an alignment across exchanges. If there are small differences, market makers quickly make use of the arbitrage opportunity and equalize the prices. The activity of market makers is the main reason asset prices in the crypto space converge globally, and there are only short episodes of price disparity. Crypto markets are then able to achieve market efficiency despite their fragmented liquidity. This increases the credibility of markets by reducing mispriced assets or more significant price differences. What retail traders get wrong about market makers Traders will often point to market makers during volatile price swings. One of the complaints is that market makers will deliberately place orders to trigger stop-loss orders, making use of the available liquidity. However, market makers do not determine price direction. They position themselves based on the general market movements. Market makers focus on their tight spreads and inventory management. They can influence prices through providing liquidity, but they do not make directional bets, instead choosing a neutral strategy and earning from spreads. Do market makers always win? In some cases, market makers can withdraw liquidity to avoid big losses. They are also taking risks with their inventory, and they are not immune to impermament loss or general trading risk. The behavior of market makers is required by their role. Market makers have incentives to trade the way they do, to benefit from spreads, low latency, and low fees. Why market makers are becoming more important in crypto Cryptocurrency trading is spreading to institutions and draws inflows from ETF traders. Markets are also growing their derivative and options trading volumes. All those market structures require guarantees for price stability. Market makers make sure there are fewer moments of erratic price movements and available liquidity within reasonable price ranges. The lack of liquidity can result in more volatile prices and impossible order-matching.
