How Crypto Market Makers Maintain Market Stability

Crypto market makers are the unseen, unsung heroes of the digital economy, helping to maintain the stability of asset prices by maintaining a constant flow of liquidity into exchange markets. They’re vitally important for the health of crypto markets, yet they must engage in a delicate and intricate balancing act that few people understand. Without market makers, the liquidity in crypto would likely dry up in a matter of minutes, causing tremendous volatility that would shake the bones of even the most seasoned traders. 

Why Does Crypto Need Market Makers?

These days, almost every new cryptocurrency project utilizes the services of market makers to ensure their tokens can be traded. In fact, they often engage with multiple market makers, for insufficient liquidity is just about the fastest way to wreck an entire token economy. 

Projects need to ensure there is ample liquidity to attract retail and institutional investors to their tokens. After all, people are only going to invest serious money in an asset if they’re sure there’s sufficient demand to offload it quickly when they need to. 

Market makers can also help token creators to boost the accessibility of their assets by listing them on multiple exchange platforms, so they can ensure it’s available to buy from any location in the world. Indeed, many of the most reputable centralized crypto exchanges require that tokens have a contract with a reputable market maker as a precondition for listing them. 

In addition, market makers can also help crypto teams to make the most efficient use of their treasury supply. By placing liquidity on strategic decentralized exchange platforms, they can ensure that liquidity follows the price, without exposing those critical assets to impermanent loss. 

How Do Market Makers Operate?

Market makers utilize a number of strategies to ensure a constant flow of liquidity. 

Exactly how they may go about doing this differs from market maker to market maker, as each one has its own, carefully crafted algorithmic trading software. For instance, Wintermute is one of the best known market makers. It utilizes algorithmic trading software that makes use of trading bots to provide fast liquidity for exchange platforms and token creators. Another market maker, GSR, provides “bespoke” liquidity and risk management solutions for digital asset creators, while also supporting institutions that want to trade large volumes of crypto assets. ‘

Another well known crypto market maker is Kairon Labs, which uses a proprietary algorithmic trading platform that it can quickly customize to meet the unique needs of any project. It bills itself as a boutique market maker, seeing each project it takes on as a partnership. For instance, its business model is designed to ensure that it only wins when its clients also win. 

Although each market maker has its own approach, as a rule of thumb they generally follow the below process: 

Post continuous orders:

The main goal of the market maker is to continuously provide two prices – the bid and the ask price – to the orderbook. These quotes are made visible to every trader, ensuring there is always a standing offer for anyone who wants to trade the asset in question. In doing this, the market maker makes sure that someone can always buy or sell the desired asset, without having to wait until another human trader is willing to match their asking price. 

This job means that the market maker must be ready and willing to trade at its quoted prices, fulfilling orders even when the market is quiet or imbalanced. By making sure they are always available, the market maker prevents liquidity from drying up, so traders can buy and sell smoothly at all times. 

Maintain inventory:

For market makers to be continuously available to buy and sell, they must maintain an inventory of the asset they’re covering. So if a buyer places an order, the market maker has enough of the asset to complete that sale. Or if someone wants to sell, it must have enough of the paired asset to enable that trade to go ahead. In this way, it’s constantly adding to, and taking out capital from its inventory, and it will need to ensure it always has enough of the asset available. 

Absorb imbalances:

A sufficiently large inventory is required to help deal with orderbook imbalances, which may occur when there is news-driven volatility. For instance, if there’s a sudden spike in demand for a crypto asset, the market maker must be able to step in on the other side and sell a large volume of the underlying asset. Alternatively, if there is a large number of sellers, the market maker must be prepared to keep buying to prevent a sudden drop in its underlying price. By doing this, market makers can help the asset to ride out volatile conditions and prevent any significant changes in its underlying price. 

Dynamically adjust prices:

It’s important to understand that just because market makers keep prices stable, they cannot prevent the price from changing, and nor should they try to do so. Rather, their job is to ensure liquidity is available, and this requires them to keep tabs on the prevailing market conditions, including the volume of buy and sell orders, price movements and market sentiments. By analyzing these metrics, it can then adjust its bid and ask prices to reflect the market condition and effectively manage its inventory levels to ensure it can meet trader’s demands.  

Execute immediately:

Perhaps the most important task of all for market makers is to be able to execute immediately, so that traders aren’t left waiting. After all, profitable trading requires being able to move quickly in order to take advantage of asset price swings, so traders cannot be left waiting for their orders to complete. They need them to be executed the moment they click that button, and so the market maker must be ready to do this in an instant. 

Ethical Market Making

For crypto projects to succeed, it’s important to understand the difference between legitimate market makers and the cowboy operators that have given the industry a bad name. Ethical market makers look to ensure sufficient liquidity, whereas the cowboy operators exist simply to try and pump token prices, using manipulative strategies such as wash trading. Although their activities may look similar, there’s a stark difference in what they actually do. 

Pumping token prices is relatively simple, and involves using automated bots to inflate trading volumes far beyond their real level, by constantly buying and selling from one another in an effort to make it look like there’s lots of supply and demand. Legitimate market makers, on the other hand, will only make as many maker and taker orders as necessary to maintain a healthy supply of liquidity. 

It can be difficult to understand the difference between ethical liquidity suppliers and token price manipulators, which is why companies like Kairon Labs provide deep analytics tools for customers to audit its activities across any exchange platform. This ensures they can keep tabs on what it’s doing to ensure it’s not artificially inflating trading volumes. 

Market Makers Make Markets Work

From this understanding of how market makers operate, it becomes clear that they are essential to create healthy, functioning crypto markets. If market makers didn’t exist, it would be almost impossible for people to buy and sell their assets instantly, making trading a much slower, more volatile and unpredictable experience. 

If people’s trades are constantly delayed and their transactions often fail, that’s going to dissuade a lot of investors from entering the market, leading to negative consequences for the entire crypto industry. 

Market makers, by narrowing the bid-ask spread and ensuring transactions are processed immediately, help to reduce costs and keep trading more predictable. They help crypto assets to ride out brief moments of volatility and enable more efficient price discovery, with prices that are a true reflection of supply and demand.