Market makers are widely considered to be an integral part of cryptocurrency markets, but their role in providing liquidity where it is needed is often misconstrued.
Since these firms are responsible for filling a large chunk of all cryptocurrency trades, there’s a good chance that you have already interacted with one without even knowing it, but do you know how they actually work?
In this piece, we’ll help to lift the lid on how market makers operate, to help budding crypto projects and exchanges determine whether they could benefit from market making services.
What are Cryptocurrency Market Makers
Market makers, or liquidity providers as they’re frequently called, are entities that are tasked with boosting the liquidity in a particular market. This is achieved by placing limit buy and limit sell orders on an exchange, ensuring that traders have ample liquidity if they’re looking to enter or exit the market.
By placing multiple bids and asks on the same trading pair, these market makers act to maximize the order book depth, ensuring that large orders can be filled without adversely affecting the market, while helping to minimize the spread. As such, market makers will buy and sell cryptocurrencies at the going market rate, regardless of whether they have a seller or buyer lined up for that cryptocurrency.
Overall, this leads to a much more attractive trading experience for users, since it allows them to worry less about slippage and losing money to the spread, and focus more on executing profitable trades. It also makes the market much more attractive to institutional and high net worth traders, that may be looking to move large sums—providing the market can support it.
Market makers also help buffer the market against flash crashes—sudden adverse price movements caused a large market order selling through all the top bids to send the market into a nosedive. This has been seen numerous times in recent months for major digital assets, but occurs regularly with illiquid cryptocurrencies.
Flash crashes are a particular problem for cryptocurrency exchanges and markets with relatively low trading volume. On these platforms, a single large sell order can chew through the order book quickly, which can cause extreme slippage for other traders placing market orders, while generating a large delta between the bid and ask prices. This is less of a concern on highly liquid exchanges or trading pairs, since a large order can typically be absorbed without adversely affecting the market.
Cryptocurrency market makers also help with price discovery, since a lower spread typically leads to increased trade volume, while large trade volume tends to move the asset towards its fair trading price. This can act to boost investor confidence while attracting further liquidity to the market.
Crypto Market Makers Differ from Traditional Market Makers
Although market makers are extremely common in cryptocurrency markets, they are also found in traditional markets, where they work to guarantee liquidity for commodities, equities, and other securities.
However, crypto market makers typically have far fewer hurdles to jump over than traditional market makers, since the market is both less competitive and less regulated. For example, market makers in traditional markets frequently spend huge sums to optimize their proximity to the exchange they offer services for, a strategy known as co-location. This ensures they benefit from reduced latency and can maximize their profits with high-frequency trading.
There are also regulatory challenges in place, since the financial authorities overseeing most major markets require traditional market makers to comply with strict rules, including those set out in the EU’s MiFID II framework, and similar regulations enforced by the U.S. Securities and Exchange Commission (SEC) in the United States.
Crypto market makers, on the other hand, are not subject to these restrictions since they do not inject liquidity into securities markets. This greatly reduces the barrier to entry, making crypto market making accessible to any individual or firm with the technical capacity and capital needed to provide these services.
How do Market Makers Make Money?
Market making is a business, and just like any business, market makers are looking to make a profit by providing their services. For the most part, these firms are employed by exchanges looking to boost liquidity across a range of markets, whereas individual companies or crypto projects might hire a market maker to ensure liquidity for their token on any exchanges it’s listed on.
Different market makers tend to specialize in different markets. Kairon Labs, for example, is arguably the most proficient market maker for altcoin markets and is typically directly hired by altcoin projects, whereas Genesis Capital, Wintermute and most other market makers tend to work more with exchanges instead.
Exactly how market makers make their money varies between providers, but there are a handful of common business models, including:
The Profit/Loss Model: Market makers employing this model will attempt to make money by buying low and selling high. This is the same strategy used by many traders, but it is particularly common among market makers, since exchanges will often offer greatly reduced trading fees or even trading fee rebates to market makers. However, since these market makers essentially generate profit from the spread, they are incentivized to maintain the spread at acceptable, rather than minimum levels which aren’t always ideal.
Profit-Sharing Model: This model sees the market maker receive a token or cryptocurrency loan from their partner, which they will use to make profitable trades. This is often combined with spread manipulation to maximize gains and is seen as a dishonest form of market making that is generally frowned upon in the trading community.
Flat Fee Model: This model sees the market maker charge the client a fixed weekly or monthly fee for their services, and the liquidity provider will simply balance their profits and losses when filling trades. This model helps to ensure the spread is minimized since the market maker isn’t incentivized to maintain a wider spread. The flat fee model is becoming increasingly popular as cryptocurrency exchanges and projects look to boost liquidity without disadvantaging ordinary traders.
Overall, market makers generally need to reach certain performance milestones as part of their agreement with the exchange or crypto project. This might include maintaining the spread within a certain threshold, providing services for a guaranteed duration during the agreement period, and filling a fixed volume of orders per day—but watch out for providers offering to meet generous KPIs on low liquidity trading pairs, as this will almost certainly involve wash trading.
Considerations When Choosing a Market Maker
When it comes to choosing the best market maker for your needs, there’s a few questions you will likely want to ask your shortlisted candidates.
The first question you will want to ask is which jurisdiction is the market maker based in? Certain regions indicate a higher quality service, with a more ethical approach to providing liquidity. For example, Kairon Labs is based in Belgium while B2C2 is based in the UK—this bodes well for the two market makers.
Conversely, market makers in less regulated regions might be borth scrutinizing more, since they may be more inclined to use more underhanded tactics. In any case, it’s wise to check the track record of any candidates, since this is an excellent indicator of their quality.
Lastly, don’t forget to define key performance indicators (KPIs) for your chosen market maker. This will likely include specifying a maximum spread, minimum order book depth, and how often their orders should be top of the order book (ToB). Watch out for market makers that offer to guarantee a price or fixed volume, since these can be indicators of intended market manipulation and wash trading—two great ways to kill investor confidence in your token.
Who are the Main Market Makers?
As interest in crypto markets has grown in recent years, so too has the demand for high-quality market making services. With that in mind, we have collated a list of some of the most reputable and well-established market makers currently operating. This list is by no means exhaustive, so we recommend doing your own due diligence and research if you are looking for market making services.
Kairon Labs has been operating since 2018 and is currently headquartered in Belgium. This liquidity provider boasts stable API connections with over 100 of the most popular cryptocurrency exchanges and provides a bespoke market making solution that includes 24/7 tweaking and monitoring by their expert traders.
Altonomy is one of the biggest players in the market making space, and boast an impressive portfolio of more than 250 digital assets across 60+ exchanges. According to the firm, it offers best in class coverage for illiquid tokens and uses proprietary trading algorithms overseen by a team with extensive crypto market experience—helping to maximize order book depth while minimizing spreads.
Comprised of a team of expert traders, programmers, and analysts, AlphaTheta works to improve token marketability by improving its stability. The firm achieves this by helping to restore liquidity, reduce the odds of delisting, and guaranteeing spreads for its partners.
GSR is one of the oldest and most reputable names in digital asset market making. The Hong Kong-based firm currently offers programmatic liquidity across 30 different venues and uses custom trading software to help drive significant volume to even the least liquid markets.
Wintermute Trading was founded by a team of fintech experts that hailed from Optiver—a renowned high-frequency trading house. This market maker provides its services to both crypto exchanges and individual blockchain projects and offers guaranteed spreads, long-standing quotes, and 24/7 liquidity.
Empirica is a provider of market making software for digital assets and has been in operation since 2010. The firm provides algorithmic trading software and a market making liquidity engine, which allows hedge funds and crypto exchanges to directly manage liquidity in crypto markets.
Headquartered in Seattle, Washington, Crypto Market Makers differentiates itself from the competition by offering both manual and algorithmic trading strategies, while also boasting a fast set up time. This liquidity provider is currently equipped to offer its services on over 100 API exchanges.
B2C2 is a prominent liquidity provider based in London, UK. The firm offers 24/7/365 liquidity for a wide array of digital asset and fiat markets, and has been operating in the market making space since 2015.
Genesis Capital offers institutional market making services, helping to support on-exchange and OTC market-making, and also provides loans to other market makers at competitive rates. The firm is an affiliate of Genesis Trading, a popular cryptocurrency OTC trading desk.