What is Market Making in Crypto?

Market making in crypto involves the process of buying and selling large amounts of a particular asset to facilitate liquidity and ensure the smooth running of financial markets. Read on here to learn more about how market making works and the benefits it brings to the crypto market.

Jun 01 2022 | ArticleBanner Image showing the words "What is Market Making in Crypto?"

Like regular stocks, commodities, and foreign exchange markets, the cryptocurrency market requires buyers, sellers, and brokers to make transactions happen on the exchange. The prices at which a crypto trader can buy a digital asset largely depend on its supply and demand, which in turn are set by the market maker.

#What is Market Making?

Market making in crypto involves the process of buying and selling large amounts of a particular asset to facilitate liquidity and ensure the smooth running of financial markets.

Market makers are high-volume traders that literally "make a market" for securities by always standing at the ready to buy or sell, thereby providing the market with liquidity and depth.

Although market makers can be members of an exchange or sole individuals, they share a common trait; they buy and sell digital assets for their personal accounts.

However, due to the high volume of crypto they deal in, large institutions often undertake market making as well.

#How Does Market Making Work?

For every cryptocurrency bought or sold, there has to be another person on the other end of the transaction. For example, if you want to sell your Bitcoin for $1,000, you have to find another person who is willing to buy $1,000 worth of Bitcoin. Because it is unlikely that you would find someone ready to sell that amount at the time you want, market makers fill in the void.

So, when you place your order, a market maker will buy your Bitcoin for $1,000, even when they do not have a client to sell your Bitcoin to right away. Thus, this reduces the wait time involved in buying and selling cryptocurrencies. When the order is more than what a single market maker can buy or sell, multiple market makers on the exchange are allowed to quote their prices on the order.

#Yellow Market Making

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#Understanding the Market Makers Strategy

Market makers in crypto are now automating the process of setting bid and ask prices, using market making software, which helps crypto market makers and cryptocurrency exchanges to populate their order books with relevant bid-ask orders at a high level, offering a tight spread, and without worrying about the potential lack of liquidity on their platform.

The automation helps market makers to almost instantaneously adjust their quotes in response to changes in the crypto market. However, human beings are limited by the pace at which they can work. In addition, automated systems have been found to be more efficient than human beings in detecting and responding to risk-oriented events.

Using automated systems for market making in crypto ensures faster response time for setting bid and ask prices, scalability, and offering 24x7 availability for traders.

#How Do Market Makers Make Money?

Because market makers hold cryptocurrencies, they risk seeing them decline in value before they can sell them to a buyer. To cover this risk, cryptocurrency market makers profit by including charges on the spread between the bid and offer price of every trade. 

In the previous example, rather than selling at $1,000, the market maker could sell the Bitcoin at $1,005. Although the spread is usually under 0.5%, the spread amount can vary, although crypto market makers must operate under a given exchange's bylaws, which are approved by a country's securities regulator.

#What are the Benefits of Market Making in Crypto?

Although market making involves a lot of risks, they are beneficial to the proper functioning of the crypto market. Market making provides the following benefits;

  1. Market making ensures that there is always liquidity in crypto markets. Without market makers, investors who want to sell their crypto would be unable to unwind their positions immediately due to a lack of buyers.
  2. Market making helps mitigate dramatic price swings and assist traders in discovering fair prices of crypto-assets.
  3. Market making reduces the wait time involved in buying and selling cryptocurrencies. This is because market makers are always on hand to buy or sell any crypto irrespective of the volume, reducing the wait time investors would need to find a person willing to buy/sell the amount they are looking to purchase or liquidate.

#In Closing: Market Makers Support the Crypto Market

As you can see, market makers provide an important service to the world's crypto markets. By ensuring there is always enough liquidity to make trades happen, and tight spreads to keep traders happy, market makers are able to provide a key service and make a nice profit off doing so. If you’re considering getting into the world of market making, there’s never been a better time to start.