BCGAME - Free 5BTC Daily Bonus!An efficient financial market generally has two types of traders: market makers and market makers. These two types of traders operating together ensure that markets function fairly and transparently, with assets being listed on several highly liquid exchanges. Every market trading participant falls into one of these two categories.
Market liquidity is one of the most important aspects of a highly efficient market. A highly liquid market is one where assets can be easily bought and sold at fair value. Essentially, there is a high demand from traders who want to own the asset and there is a large supply from traders who want to sell the asset. While even small retail investors can be market makers, placing orders that are not immediately executed, such as limit orders, the most prominent market makers are large financial institutions such as Morgan Stanley, Goldman Sachs, The Vanguard Group, Blackrock and Fidelity Investments , between others.
In this article, we will discuss:
What is a market maker and a market taker in cryptocurrency?
The concept of market maker and market maker in cryptocurrency markets remains the same as in traditional financial asset markets such as stocks, commodities and foreign exchange (Forex). These two entities are the lifeblood of any cryptocurrency exchange, and it is their presence (or rather, lack of it) that differentiates a strong and robust exchange from a weak exchange. Since exchanges often use an order book to manage multiple trading pairs, these market participants ensure that the order book works fairly and transparently.
In cryptocurrency markets, as part of the decentralized finance ecosystem (DeFi), there is the concept of automated market makers (AMMs), which is the underlying protocol that feeds all decentralized exchanges (DEXs). AMMs eliminate the need for centralized exchanges and traditional market-making techniques that can sometimes lead to price manipulations and liquidity crises. The equivalent of trading pairs commonly found on centralized exchanges are liquidity pools for DEXs.
What is a market maker?
Market makers are individual participants or member firms of an exchange that trade securities for their own account. They act as providers of liquidity and depth to the market in exchange for being able to profit from the bid-ask spread of various orders from the exchange's portfolio of offers.
Who are the market makers?
Traditionally, large brokerages are the most common market makers offering investors solutions to buy and sell assets. The market allows market makers to profit from the spread, as they assume the risk of holding the assets, as their value can decrease between a purchase by the market maker and a sale to another buyer.
What is a Designated Market Maker (DMM)?
There is also the concept of a designated market maker (DMM), in which the exchange selects a primary market for a specific traded asset. These market makers are responsible for maintaining prices and quotations and facilitating the purchase and sale transactions of this asset. The New York Stock Exchange (NYSE) DMMs are known as experts. A specific market maker may be creating markets for hundreds of assets at the same time. A DMM is often hired by the bond issuer to “make the market,” that is, to provide depth and liquidity. Credit Suisse, UBS, BNP Paribas and Deutsche Bank are market makers in global equity markets. While brokers compete with each other, experts ensure that offers and orders are properly informed and disclosed.
How do market makers trade?
Market makers generally operate on both sides of the market. They charge a spread on the buy and sell price of the asset for which liquidity is provided. Manufacturers also maintain quotes for bid and ask prices. Traders wishing to unload an asset on the market would have the trade executed at the asking price, usually slightly lower than the market price. Investors who want to add an asset to their portfolio need to pay the selling price, usually a little higher than the market price. These differences between the market price and the bid and ask price are known as spreads, and this is the profit market makers make on trades executed by market makers. They also earn commissions for being liquidity providers (LPs) to their clients.
Can Market Makers manipulate the market?
While it is ethically questionable for market makers to execute, it is possible for them to manipulate the price of the asset for which they are providing liquidity through collusion and collaboration with other market participants. From this theoretical possibility emerges the common folklore or the so-called “urban legend” of the market maker's signals. However, to prevent insider trading, the US Securities and Exchange Commission (SEC) has banned instant messaging between market makers about trades queued for execution.
How do automated market makers work?
No cryptocurrency market , projects like UniSwap that run AMMs have gained speed and credibility over the last couple of years. Compared to the traditional model of decision makers, AMMs allow the market to function autonomously and decentrally on decentralized exchanges (DEXs).
DEXs replace the order book systems that exchanges use to match orders between buyers and sellers with AMMs. AMMs use smart contracts to price the asset and provide liquidity for it on the exchange. Instead of trading against counterparties, investors are trading against pools of liquidity. There are several liquidity pools for specific trading pairs, DEX users can choose to become a liquidity provider (LP) by depositing a certain predetermined proportion of the chosen trading pair.
AMMs usually use a predefined mathematical equation to establish the relationship between the assets held in the liquidity portfolio. LPs are rewarded with a certain percentage of the fees paid on transactions executed in the pool. They also receive protocol governance tokens in addition to users.
One of the main risks associated with AMMs is impermanent loss.
What is a Market Taker?
Market takers are market participants in the trading ecosystem who seek immediate liquidity to make a trade and execute their position. This means that they work in a symbiotic relationship and need each other to achieve their respective goals.
Who are the market takers?
Market takers are generally traders and retail investors who profit from asset price movement or use asset price movement as a hedge for the other positions in their portfolio. As market makers generally modulate their positions less frequently than market makers, higher trading costs are less of a concern. Even market makers who trade frequently tend to have a smaller impact on market dynamics than market makers, due to the volume and number of transactions executed by them.
Large banking institutions and corporations can also be market takers if they need to settle or execute specific transactions immediately, rather than waiting for the optimal buy and sell price to be executed.
What are the market maker and market maker fees?
The maker-borrower model for trading is a way of differentiating rates between maker orders that provide liquidity to the trading pair and taker orders that take liquidity out of the market. Both orders imply a different fee structure for market participants. While market makers earn profits or protect their portfolio through price movements, market makers often earn a buy and sell spread to provide liquidity for a particular asset.
Conclusion
The maker-taker model is the most widely used pricing model for assets listed on central exchanges. Although this traditional model is now seeing innovation and competition through Automated Market Makers (AMMs) and Electronic Communications Networks (ECNs), its market relevance is still very prominent and highly essential for the efficient functioning of an asset's market.
