What is Market Maker? The operation of Market Makers in the financial market

What is Market Maker?

A Market Maker (abbreviated as MM) is an individual or organization with substantial capital and experience, specializing in providing trading services and liquidity to the financial market. They accomplish this by buying and selling assets such as tokens, stocks, bonds, currencies, and commodities at pre-established prices. This enhances market liquidity, making it easier to buy and sell assets. Market Makers play a crucial role in maintaining a liquid and efficient market by facilitating trading activities and ensuring a continuous flow of prices for various financial instruments.

Market Makers typically maintain a small spread between the buying and selling prices, providing liquidity to the market. This attracts more buyers and sellers, leading to higher trading volumes. Increased trading volume contributes to higher profits for the Market Makers.

Market Makers play a crucial role in maintaining the flexibility and liquidity of a particular asset, ensuring that the market operates smoothly and efficiently. They are often compensated through commission fees for the trades they facilitate. Additionally, they may generate revenue by the spread between their buying and selling prices.

The way Market Makers operate

Market Makers operate by buying and selling assets at predetermined price levels. These price levels are referred to as the bid price and ask price. The bid price is the price at which the Market Maker is willing to buy the asset, and the ask price is the price at which the Market Maker is willing to sell the asset.

When an investor wants to sell an asset, they place a buy order at the bid price. The Market Maker will match this buy order with a sell order from another investor, or the Market Maker will sell the asset to the investor at the bid price.

Similarly, when an investor wants to buy an asset, they place a sell order at the ask price. The Market Maker will match this sell order with a buy order from another investor, or the Market Maker will buy the asset from the investor at the ask price. This continuous process of matching buy and sell orders helps maintain liquidity and market efficiency.

How Market Makers Profit

Profit-making for a Market Maker primarily involves two main methods:

• Price Spread: This is the most common way for Market Makers to generate profits. They set bid prices slightly lower than ask prices. When an investor places a buy order at the ask price, the Market Maker matches this buy order with a sell order placed at the bid price. Through this method, the Market Maker earns a profit from the difference between the buy and sell orders.

• Commission Fees: Market Makers also earn money by charging commission fees for each trade they facilitate. These fees are typically levied on large investors who execute high-volume trades.

The ways in which Market Makers generate profits are depicted in the diagram below:

The more significant the trading volume, the more profit a Market Maker can generate. Therefore, they always aim for the most active market possible. To achieve this, Market Makers often utilize price-driven marketing techniques through pump and dump activities in tokens to create a Fear of Missing Out (FOMO) effect, attracting investors, especially those new to the market.

Why is a Market Maker important?

Market Makers are essential for various asset types, especially cryptocurrencies, because liquidity is a crucial factor in ensuring the continuity and stability of the financial market. High liquidity allows investors to easily buy and sell assets at reasonable prices with reduced risks.

During the initial stages of listing a new asset, liquidity is often low. Market Makers step in as third parties to provide liquidity to the market by buying and selling those assets. In other words, Market Makers act as intermediaries, connecting buyers and sellers, facilitating smooth transactions. Here are some benefits that Market Makers bring to the market:

•  Creating Liquidity: Market Makers consistently buy and sell assets at reasonable prices, making it easy for investors to trade those assets.
•  Attracting Investors: When an asset has high liquidity, investors have more opportunities to trade that asset. This helps attract investors to the market and promotes market growth.
• Risk Mitigation: When investors want to buy or sell assets, Market Makers are always available to execute trades, ensuring that transactions are conducted safely and efficiently, minimizing risks for investors.
• Fostering Competition: Market Makers compete with each other to provide the best liquidity to the market. This helps create competition and reasonable prices for investors.
• Increasing Market Transparency: Market Makers provide information about asset prices and trading volumes. This enhances market transparency and helps investors make more informed investment decisions.