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Tuesday, April 16, 2024

How Market Makers Provide Liquidity to the Market: Strategies

When choosing a trading platform, you usually pay attention to its characteristics which include liquidity, security, tools, trading volumes, customer support, etc. In this article, we will take a closer look at liquidity, as it stands as a cornerstone, influencing the efficiency and functionality of trading platforms.

Consequences of the Lack of Liquidity

If there is insufficient trading activity and a lack of buyers and sellers for a particular digital asset, that means a low liquidity level. In such cases, it becomes impossible for traders to perform traders quickly and at desired rates. Insufficient liquidity leads to wider bid-ask spreads (buy and sell prices), increased price slippage, and difficulty in entering and leaving positions. These all significantly affect the market price and in such a situation, traders face difficulty in keeping risk managed.

How Market Makers Contribute to Liquidity

The ease with which assets can be bought or sold without significant price impact is a crucial factor for traders and investors. Market makers play a central role in this ecosystem, actively participating by posting continuous buy and sell orders. Their presence ensures liquidity, tight bid-ask spreads, and a smoother trading experience, contributing to the overall health and stability of crypto markets and global crypto adoption.

A crypto market making company is an individual trader, financial entity, or institutional investor that possesses capital to pour liquidity into crypto markets. In return, market makers receive reduced fees and rebates, and make their profit from bid-ask spread.

Strategies

Let’s discuss some of the strategies in market making:

Cross-exchange liquidity mirroring – placing buy and sell orders on a maker exchange while hedging trades on one or more taker platforms.
Without hedge – often performed by market-making bots and sophisticated algorithms. A trader provides liquidity in the market without using hedging techniques. While it simplifies the trading process, it also exposes the trader’s capital to higher levels of risk.
Delta neutral market making – cryptocurrency market maker aims to maintain a balanced portfolio by offsetting the directional risk of their positions. This involves adjusting the portfolio’s delta to zero, ensuring that changes in the underlying asset’s price have minimal impact on overall profitability.
Grid trading – a trader places a series of buy and sell orders at pre-set price levels above and below the market price or a moving average. The orders create a grid, and the strategy aims to profit from price fluctuations within this grid, typically generating returns through spread differences.

Conclusion

Liquidity is the lifeblood of trading platforms, and without it, they just lose their essence. Market makers play a crucial role in maintaining trading platforms’ liquidity, ensuring a healthy trading environment, which helps attract more traders and investors.

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