Cryptocurrency Market Making - The Comprehensive Details You Need to Know
For people used to traditional financial markets, entering the crypto space can be quite refreshing and exhilarating. Open markets full of opportunities, high volatility, innovative products & solutions, countless tokens, and an abundance of exchanges on which these tokens trade. However, just like in other markets, there is one essential factor that determines how attractive and easy it is to trade: Liquidity. A liquid token can easily be bought or sold at any time, without causing a significant price change. The more liquid a token is, the more attractive it is for traders. Understanding the importance of liquidity in cryptocurrency market making is the prerequisite for understanding why market makers play such a crucial role both in traditional finance and in the crypto industry.
What Is The Main Activity Of Market Making?
To organize the trading activity, most exchanges use something called the "Order Book". Two types of orders can be submitted to the Order Book, namely "market orders" and "limit orders".
Market orders are transactions meant to execute immediately at the currently available market price.
Limit orders are orders to buy (or sell) an asset at no more (no less) than a specific price.
The primary objective of a market maker is to create a healthy and active market for buyers and sellers. They do this by placing passive "limit orders" into the order book of exchanges on both the buy and the sell-side. By making sure there are continuous orders in the market on both sides of the order book, the market maker is offering the liquidity that bridges the gap between the sellers and buyers. The more orders there are in the order book, the more liquid the market for this specific asset is. We refer to this as "Order Book Depth".
The market maker also ensures that the highest buy order and lowest sell order are not too far apart. The distance between these two is called the "bid/ask spread". Liquid assets have smaller spreads and are therefore more attractive to trade.
Market participants benefit from the market maker's activity, but how does the market maker benefit? Well, when done intelligently, market making can be highly profitable. The source of the profits lies in the "spread" defined above. The market maker constantly tries to capture this spread by selling at slightly higher prices than the buy prices.
What Is Crypto Market Making?
Everything that was written so far, is not specific to the digital asset industry, but for financial markets in general. So why is the cryptocurrency market making particularly important in the crypto ecosystem?
Since crypto markets are still very young, they are mostly still very illiquid and highly volatile. Sure, tokens such as Bitcoin or Ether have reached a certain level of maturity and have high trading volumes on the largest exchanges, but one has to be aware that there are thousands of tokens, listed on hundreds of crypto exchanges. What all of them have in common, is that they will only survive if they can ensure liquid markets for their users. Hence, they rely on market makers.
Automated Crypto Market Making
Most market makers do not manually place individual orders into the order book of exchanges. Speed and intelligent adaptation to changes in the markets are essential for successful cryptocurrency market making. This is why market makers work with fully automated trading algorithms. The quality and sophistication of these algorithms vary, but the leading firms in the space rely on the most advanced concepts in AI and machine learning to deliver optimal results. These algorithms enable placing thousands of orders every day at high speed and, once properly tested, keep human involvement at a bare minimum. This is particularly important in crypto markets that, unlike traditional markets, are open 24/7.
The limiting factor for these automated trading strategies today is the level of the technology infrastructure offered by crypto exchanges. Sophisticated traders are highly dependent on the quality of the connectivity to exchanges. Since most crypto exchanges were set up at high speed and with a clear focus on retail, the industry is still far away from the standards one might be used to from more established financial markets. However, given the unbelievable pace at which the industry is developing, it is only a question of time before this gap is closed.
Why Do You Need A Crypto Market Maker?
Hopefully, the paragraphs above have convinced you of the importance of liquidity for any exchange or token. To state it in the plainest terms: illiquid tokens and markets die off, while liquid tokens and markets prosper.
If you are an exchange and your name does not happen to be Binance or Coinbase, you are in intense competition with hundreds of other exchanges for a growing but still limited user base. A market maker will make sure the spreads on your exchange are competitive and your markets are attractive to traders. You might also differentiate yourself by offering many tokens for people to trade. This only works if all of these tokens CAN be traded all the time, which, again, implies the presence of a market maker.
For token issuers, the situation is even clearer. If you want to list on any centralized exchange, any serious exchange will only let you do so if you work with a market maker. Unlike exchanges, it is not your job to be an expert in financial markets. Having a partner that is specialized in making markets for illiquid tokens allows you to focus on your project, rather than constantly worry about the market for your token.
Flovtec – Your Trusted Partner For Crypto Market Making
Flovtec is a Swiss technology company that offers easy access to market making solutions for tokens and digital asset exchanges. Our goal is to solve your liquidity needs by enabling a healthy market, with deep order books and tight spreads.
For exchanges, we have developed algorithms that are ideally suited to make markets for the more liquid cryptocurrencies such as Bitcoin, Ether, or Litecoin. For token issuers, we have developed algorithms that are specialized for more illiquid tokens, in particular where there is no known reference price.
Liquidity is the prerequisite for cryptocurrency market making, for higher trading volumes, more users, and, ultimately, for healthy price appreciation. When done properly it makes markets more healthy, stable, and efficient. The question for any exchange or token issuer is therefore not "if" they need a market maker, but "how" to select the right market maker. We will cover this in a future blog post.
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