Ensuring sufficient liquidity is one of the most critical factors for a successful transfer of cryptocurrency assets between users. There are two primary market-making methods that exchanges utilize: decentralized exchanges (DEXes) mostly rely on automated market makers with liquidity pools, and centralized exchanges (CEXes) generally use order books that collect active buy and sell orders in one place. Regardless of the method, both CeFi and DeFi projects are continually seeking ways to attract enough liquidity, sustain demand, and maintain reasonable prices to entice users.
In the case of order books, exchanges need to ensure that when a trader decides to buy 1 ETH at $1,303, another trader is willing to sell 1 ETH at that price, thus acting as an intermediary between them. However, the less popular a crypto asset is, the higher the chance that traders will not execute trades quickly and at the desired rates.
Therefore, exchanges need individuals willing to buy and sell different assets 24/7, trading against users. Such individuals are called market makers.
Market makers are entities responsible for creating and maintaining liquidity in the crypto market. They facilitate the exchange of cryptocurrencies on exchanges by serving as both buyers and sellers of specific tokens or coins, ensuring that there are enough funds available to maintain a stable trading environment throughout the day.
Market makers are typically large crypto companies or high-net-worth professional traders with enough liquidity to fill the market. However, as the industry evolves, new opportunities for market-making are becoming available to individuals and smaller companies as well. Some exchanges also take up this role themselves to ensure a steady exchange process.
Facilitating orders alone is not always enough to maintain a stable market, so market makers use various strategies. For instance, they may place differently priced orders to create a range of buying and selling options for traders. They may also use algorithms to examine market trends and make trades accordingly. Additionally, they may buy and sell crypto assets with their capital to ensure that trading for certain asset pairs remains active.
Market makers do not just provide liquidity but also assist in addressing one of the biggest challenges that hinder the market's growth - volatility. By continuously posting buy and sell orders, they help to balance the fluctuations in demand and supply.
For instance, a sudden surge in demand for a particular token can cause its price to rise rapidly. However, market makers can absorb this demand, at least partially, by selling more, thereby preventing the market from becoming too volatile and unstable. As a result, market makers assist exchanges in making the crypto market more predictable, functional, and appealing to users.
Market-making attracts traders and companies through arbitrage opportunities. Market makers can profit from the difference between the buying and selling prices of crypto assets they trade throughout the day. For instance, if a market maker buys a crypto asset for $140 and later sells it for $147, they earn an extra $7.
This price difference not only generates a profit but also serves as a safeguard against unfavorable market conditions and risks that market makers take on by purchasing and holding assets that might decrease in value before they can be resold. Moreover, many exchanges offer market makers various financial incentives, such as reduced trading fees or rebates, to encourage them to trade on their platforms.
Even though market makers are typically associated with centralized exchanges, there is a way for decentralized exchanges to also work with them - RFQ (request-for-quote) orders.
The RFQ system is designed to provide liquidity to DEXes in a simplified and profitable manner while reducing risk for both market makers and users. On the one hand, market makers are required to sign their quotes to ensure that they remain unchanged until the trade is finalized, thus protecting traders from price slippage and other attacks such as front-running. On the other hand, market makers can choose when and with whom they want to exchange, allowing them to adjust their market-making strategies to maximize profits.
The RFQ feature is particularly useful in attracting large market makers who typically trade crypto assets on CEXes to DEXes, thereby redirecting significant liquidity towards decentralized exchanges.
There is a debate among crypto enthusiasts regarding the role of market makers in the industry. Some argue that market makers may manipulate prices by creating artificial volatility, which they can then profit from, or engage in unethical or illegal activities, such as front-running or spoofing. Others believe that despite the criticism, the role of market makers will become even more crucial as the crypto industry matures, as the demand for liquidity and stability in the market is only expected to increase over time.
The Kinetex team is planning to enable market makers to work with Kinetex. The upcoming second mode of the Kinetex dApp, called Flash Trade, will allow users to swap assets directly with market makers with the help of zero-knowledge technology. This way, Kinetex will be able to attract more liquidity to the platform while giving makers new profit opportunities.