Market making in the context of cryptocurrencies involves similar principles to traditional financial markets. It refers to the process of providing liquidity to exchanges by placing buy and sell orders (the “bid” and “ask”) for a particular cryptocurrency on the order book. This process helps to narrow the spread between the buy and sell prices and allows trades to occur more smoothly.
Market makers make profits from the spread – the difference between the buy and sell price. They buy low and sell high, making the spread as their profit. They maintain an inventory of a specific cryptocurrency and constantly update their bid and ask orders, adjusting to the changing market conditions.
Crypto market makers can help stabilize the price of a particular coin or token and increase its trading volume. Without market makers, cryptocurrencies with lower volumes might suffer from high price volatility, as trades could significantly impact the price.
In crypto, market making is particularly important due to the fact that there are many different exchanges where trading takes place. Since the liquidity can be spread thin across these many exchanges, market makers play a key role in ensuring that there is enough volume for traders to buy and sell without causing massive price swings.
However, it’s important to note that market making, while legal and crucial for smooth market operations, carries risks, including the risk of holding an inventory that might decrease in value. In a highly volatile environment like cryptocurrency markets, these risks can be significant.