How does Market Making work?

2023-01-25, 06:31

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Previously, we gave an overview of an introduction to market makers and why they are important [here](https://www.gate.io/blog_detail/2062/what-is-market-making?cate_id=10 "here"). In this article, we will dive deeper into the mechanism of market making and its crucial role in ensuring market stability.

Market makers play a crucial role in financial markets, by facilitating the buying and selling of securities and promoting liquidity.

You can think of them as a middleman - they deploy their own funds to buy and sell assets, and keep them in their own inventory. Investors can go to them whenever they want to buy and sell.

By standing ready to transact at all times, market makers ensure that there is continuous liquidity in the market.

With reference to Token X, to put it simply:

&#9679; If an institution buys a large amount of Token X, demand for the limited supply of tokens left on the market increases sharply.

In this instance, what a market maker can now do is to sell a large quantity of Token X from their own wallet, which increases the supply to cushion the demand and help prevent the price from spiking unnecessarily.

&#9679; When the institution sells Token X and floods the market, market makers can buy a large quantity of the token themselves, which helps to mitigate the increased demand and prevent prices from crashing unnecessarily.

## How do market makers remain profitable?

Exchanges or DEXes that hire market makers to provide general liquidity for listed securities may be paid a flat fee, or earn from the spreads made through trades.

Projects that hire market makers to provide liquidity for their specific token typically pay a flat fee, sometimes with performance commission on top. Another model that market makers in cryptocurrency offer is a coin loan model which allows them an option to purchase the token in the future.

Of course, it’s not irregular for market makers to sell assets at a loss - after all, they are obligated to hold certain amounts of an asset in order to provide liquidity for the stipulated uptime, and fulfill all orders placed instantly.

Market makers are also allowed to take a cut, known as the bid-ask spread. This is the difference between the bid price, the highest price they’re willing to offer for an asset, and the ask price, which is the lowest price they’re willing to accept it for.

Market makers also earn through the arbitrage of prices between different exchanges. The process is the buying of cryptocurrency in one market and selling it in a different market at a higher price, earning the price difference in profit.

## What other benefits do market makers provide?

By buying and selling assets constantly, market makers narrow the bid-ask spread. A narrow bid-ask spread is generally considered favorable to investors as the price offered is less far off from the accepted price. With a reasonable price gap between the offered and accepted price, people can be encourage to participate in trading these assets.

Market makers also help to increase the depth of order books, which is a digital record for the history of buy and sell orders of a particular asset. To informed investors, the order book is a helpful tool to find out the health of the asset - it reveals the amount of orders that are open at a range of prices, as well as any imbalances or resistance levels. Deep order books can attract investors as it indicates a liquid market, which can reduces risk for investors.

## Recap

&#9679; Market making is the act of facilitating the buying and selling of securities, and promoting liquidity in the market.

&#9679; They help in price discovery  prices by cushioning the supply and demand forces and stabilizing prices to market level. They make profits by taking a cut, known as the bid-ask spread and arbitrage across exchanges.

&#9679; Market makers play a crucial role in financial markets by facilitating liquidity and market stability, and their presence is essential for attracting and retaining investors.

***Disclosure: This article was written in partnership with DWF Labs, a market maker and Gate.io institutional client. For more information on DWF Labs, visit [www.dwf-labs.com](http://www.dwf-labs.com/ "www.dwf-labs.com")***

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<div>Author:** DWF Labs**
<div class="info-tips">\*This article represents only the views of the researcher and does not constitute any investment suggestions.
<div>\*Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all cases, legal action will be taken due to copyright infringement.
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