The Ultimate Guide to Crypto Market Making: How It Works and How to Be Effective

Market making is a fundamental feature of financial markets, essential for providing liquidity and performing trading. Market makers commit to buying and selling assets at all times, thus forming trading volumes and markets for others to trade efficiently.

Market makers are essential participants in financial markets, providing liquidity and facilitating trading by committing to buy and sell assets at all times. In the crypto space, market makers play a crucial role in creating healthy markets and contributing to price discovery. Camille Meulien, CEO of Yellow Capital, highlights the importance of effective market making, which entails robust risk management, strategic order placement, constant market monitoring, and adaptability to varying conditions.

Together with Yellow Capital, we delve into the world of crypto market makers and explore their strategies for optimal performance, ultimately contributing to more efficient and stable markets.

Why are trading volumes so important?

Throughout history, high trading volumes in crypto markets have indicated an active, healthy market with sufficient liquidity for entering and exiting positions. These volumes aid in price discovery, signaling confidence in the marketplace and reducing the likelihood of sharp price movements.

Market makers contribute to these volumes by continuously placing both buy and sell orders, aiming to keep the trading operations alive and facilitate other market participants.

What is crypto market making?

Market making involves the strategic provision of liquidity for different crypto trading pairs by constantly buying and selling specific assets, creating a healthy trading environment for the organic growth of new traders and investors.

Liquidity is the lifeblood of the crypto market. Without it, markets become empty and inactive. Being liquid (having liquidity) means that an asset can easily be bought or sold in the market and can be disposed of without experiencing much price change.

MMs (market makers) increase liquidity by managing the order book, simultaneously increasing stability in prices and confidence among traders.

Initially, the idea of a market making business was to benefit from the bid-ask spread, which is the difference between the buying price (bid) and the selling price (ask).

Evolution of market making

While market makers traditionally earned their primary profits through the spread, crypto market makers have shifted their focus over time, offering a range of services. They now act as a middleman for market participants, investing in early stages and assisting crypto projects with token launches and even incubation. It's no exaggeration to say that market makers have become among the most influential and important crypto market participants.

What do market makers really do?

Manage bid-ask spread

The bid-ask spread is the difference between the price a buyer will pay (bid) for an asset and the price the seller will take (ask).

Market makers adjust the spread to decrease it, build stability and trading volumes, create arbitrage opportunities and sometimes make a profit.

They do this by following the steps below.

Setting the bid and ask prices

Good market makers set bids and ask prices competitively to attract trades while managing risk. They consider current market prices, volatility and trading volume.

For example, during high volatility, a market maker might widen the spread to account for the increased risk of price swings.

Market conditions adaptation

Market conditions can change quickly, and a good market maker must change the orders to fit the prevailing market conditions.

For instance, when the market is generally on an uptrend, a market maker would adjust the bids higher for a competitive edge and lower the asking price just a bit to capture more trades.

On the contrary, he would lower his bids and adjust his asks to control risk in a downtrend.

Order size management

Balancing order size is crucial for market makers. On the one hand, placing too big an order exposes the entity to too much risk – at the same time, placing too small an order may not make the liquidity provision business worthwhile to the liquidity provider.

For instance, a market maker might increase order sizes in periods when trading activity is heavy to be able to fill large trades.

The frequency of order updates keeps market makers competitive and actively regulates risk. They use automated trading systems to help adjust orders in real time by changing their price according to market movements.

For example, if the prices have changed due to a significant news item, the system would automatically make necessary adjustments to keep order levels at an appropriate amount.

Manage order book

The order book is a list of buy and sell orders for an asset, organized by price level. It gives the quantity of assets available at each price.

The market depth that an order book reflects regarding how many orders are placed at various price points indicates market sentiment and trading activity.

Crypto market makers are responsible for a proper order book structure and depths to protect the price from high volatility and unwanted actions.

They do this by following the steps below.

Manage order book depth

An order book’s depth is crucial to stabilizing markets. There must be enough orders from buyers and sellers at different price levels.

Market makers, in their endeavor to ensure adequate depth, post orders at various price levels to ensure liquidity always exists. This ensures that there is no massive price swing because of single trades.

Handling large orders

Large orders can have a huge impact on the price when they come into the market. A good market maker will handle this by absorbing those trades with their own orders

The above is the detailed content of The Ultimate Guide to Crypto Market Making: How It Works and How to Be Effective. For more information, please follow other related articles on the PHP Chinese website!