Crypto Market Making: What It Is and How It Works

There are many components behind efficient cryptocurrency exchanges. Among them is crypto market making, a process that allows traders to buy and sell cryptocurrencies seamlessly. 

Crypto market making involves placing bid (buy) and ask (sell) orders in a crypto exchange to provide liquidity to the market. The more liquid the market is, the more attractive it is to potential participants and the better their trading experiences. 

In this guide, we’ll take an in-depth look at crypto market making and its invaluable role in the cryptocurrency sector. 

What Are Market Makers?

Market makers are institutional investors or individuals who actively buy and sell cryptocurrencies, not simply to make profits like traders, but to ensure efficient trading by providing liquidity. 

Market makers serve as intermediaries between sellers and buyers, allowing them to execute their trades quickly without causing price fluctuations. They may enter an already functioning exchange and trade in existing cryptocurrencies to tighten the bid-ask spread or help bring attention to a new token by offering continuous buy and sell orders. 

Assume you have two traders: X looking to sell and Y looking to buy. A market maker can facilitate the trade and tighten the bid-ask spread by setting a buy price of, say, $9.95 and a sell price of $10.05. 

Market Makers vs. Liquidity Providers

While market makers and liquidity providers both promote market and exchange liquidity, they aren’t the same. Market makers take a proactive role, actively placing buy and sell orders in the market. 

Conversely, liquidity providers are passive participants. They establish a liquidity pool by depositing orders into the market for other traders to use. Unlike market makers, they don’t balance orders or actively set bid and ask prices. 

How Does Market Making Work in Crypto?

Market making is the force that works behind the scenes to keep financial markets and exchanges healthy and vibrant. Here’s how it works in crypto.

Liquidity Provision

Market makers ensure there are always buy and sell orders available, thus providing liquidity to the market. They typically use automated cryptocurrency trading algorithms to monitor market conditions and place necessary orders in real time to ensure there’s adequate cryptocurrency demand and supply. 

Price Stability

Price volatility is a significant risk in the cryptocurrency market. Market makers help mitigate this risk by absorbing large orders. For instance, if there’s a sudden increase in sell orders in an exchange, they step in and buy the excess orders, minimizing the risk of abrupt price drops. 

They also help reduce slippage by maintaining multiple orders at varying prices. This keeps prices from moving too drastically to match trading orders. 

Bid-Ask Spread

Market makers help maintain a tight bid-ask spread by employing various trading strategies. The first one is setting bid and ask prices that are very close to each other. 

For example, if a crypto asset‘s market price is $10, they may set a bid price of $9.95 and an ask price of $10.05, effectively creating a narrow spread. They continuously place these bid and ask orders, enhancing a market’s liquidity without fluctuating prices. 

Market makers also tighten the bid-ask spread by balancing asset supply and demand. If there’s an influx in buy orders, they may increase their ask prices and reduce their bid prices to try to balance things out. 

Benefits of Crypto Market Making

Market making is invaluable in the crypto space. It increases liquidity, limits asset price fluctuations, enhances price discovery, and promotes token adoption. Below, we’ll take a deeper look at these benefits.

Increased Liquidity and Order Book Depth

A crucial role of market making is to ensure liquidity and enhance order book depth by providing continuous buy and sell orders. This makes it easy for participants to enter and exit the market, creating a vibrant trading environment. 

With the right market makers, you can make your exchange more appealing to potential traders and boost trading volumes. 

Reduced Volatility

By employing strategies like absorbing large orders and maintaining continuous price quotes, market makers dampen price swings, promoting a more stable market environment. This can be attractive for risk-averse traders who want to participate in a “predictable” market. 

Improved Price Discovery

Market makers place multiple orders at different prices, adding depth to the order book. A deep order book reveals the prices at which traders are willing to buy and sell assets, helping the market determine fair prices. 

They also participate in high-frequency trading, placing continuous orders and regularly updating their bid and ask prices. This level of participation increases trading activity, which can highlight the crypto market’s consensus on an asset’s value. 

Market Making for Token Adoption

Market makers facilitate token adoption by building on an asset’s stability, trust, and market performance. Here’s how they do it.

• Stability: They create asset stability by tightening the bid-ask spread and reducing price volatility. The more stable an asset is, the more willing market participants are to trade it. 
• Trust: Market makers enhance token liquidity by maintaining constant bid and ask orders. This, in turn, boosts organic trading activities and elevates tokens’ positions in the market, resulting in increased trust. 
• Market performance: Beyond actively maintaining the health of the crypto space through enhanced liquidity and narrow spreads, market makers provide token performance data to issuers in the early stages. This allows them to make well-informed improvements. For example, if performance data reveals low trading volumes, issuers can increase their marketing efforts. 

Note: The role of a market maker isn’t to inflate trade volumes. Their role is to enhance market liquidity to encourage organic trading. So be wary of makers who guarantee increased token adoption or promise to register specific trading volumes, as they may use unethical tactics like wash trading to meet targets. 

Harness the Power of Market Makers More Effectively With AlphaPoint

Crypto market makers are key players in the cryptocurrency and digital asset ecosystem. They enhance liquidity, help tighten bid-ask spreads, and prevent price volatility, often resulting in greater token adoption. 

If you have a crypto exchange or are in the process of developing one, partnering with the right market makers can improve your platform’s appeal to traders — and AlphaPoint can help. 

We empower crypto exchanges to build strong relationships with market makers, fostering a more liquid, stable, and compliant trading environment. With us, you get fully developed API tools that allow market makers to connect their algorithms to your exchange without affecting uptime. 

Ready to partner with market makers to enhance your crypto trading environment? See what AlphaPoint can do for your exchange!