Back in 1990, Mike Godwin noticed that as the Internet discussion grows, the probability of mentioning nazism and Hitler in it increases. If we adapt this law to the realities of the crypto market, it will sound like this: in any rather lengthy discussion of the market situation, «whales» opposing «simple traders» will be mentioned.
But if the nazism of the participants in the discussion is almost always a purely rhetorical trick that is used when arguments run out, then the «whales» are an objective reality. They really exist and strongly influence the market. Therefore, they were named market makers.
Who are market makers
These are mean, soulless, cynical, cruel big players who who spoil the life of ordinary traders. This will be the collective image of market maker, if you make it according to the descriptions of crypto traders. Such a monster of the entire crypto market, which is convenient to justify their unprofitable deals.
It is not surprising that in reality market makers are somewhat different from this image.
Market maker is the one who makes the market. This name accurately reflects the essence of market makers — these are large organisations, very rarely individual players, whose transactions create the market. Where there are none, normal trading is impossible.
A good example is the trading of unpopular coins, when a buyer for an order (an application for the purchase or sale of a coin) can be waited for weeks, and the price often jumps multiple times with each transaction.
Why market makers are needed
Market makers are responsible for:
💧 creating liquidity;
🪙 ensuring price stability;
💧 Creating liquidity
To simplify it, liquidity is, in fact, the speed with which you can buy or sell any product. The faster the transaction can be carried out, the more liquid the asset is.
For example, US dollars are almost absolutely liquid as they can be exchanged for goods in almost any corner of the world in a matter of seconds. And real estate is a low-liquid asset, since it can take months or even years to get a deal.
Modern exchange trading of low-liquid goods is impossible. Therefore, the supply of liquidity to the market is the main function of any market maker. In the professional environment, such a player is even called a liquidity provider.
What does liquidity provision mean? How does a market maker do this?
Everything is simpler than it seems: market makers hold two large orders on the market at any given time. For example, one of them is for the purchase of cryptocurrency for $99, and the second is for sale for $100. At the same time, the difference between the price of purchase and the price of sale (spread) falls into the pocket of the market maker.
How a market maker works on the market. Source: bitpanda.
The size of these orders depends on the current market situation: volatility, trading volume, expectations of important news. There are hundreds of parameters. All of them are analysed by a complex algorithm that immediately changes both the size of the market maker's orders and their price.
In addition, the contract with the exchange provides for a minimum amount of liquidity that the provider must pour into the market. At the same time, the total amount of orders (for example, at least one million dollars) and the time interval (for example, from 12 to 17) are set. These commitments are usually kept in the strictest secrecy so that other major players cannot use them to play against the market maker.
Such multidirectional orders allows everyone who comes to the market to quickly make a deal even if at this moment there will be no opposing orders from other players on the exchange. The one who wants to sell an asset will find a buyer for it in the person of the market maker, and the one who wants to buy will find a seller.
Let's say there is a new Thebestcoinever token. It was listed on the stock exchange, but there is almost no trading, and spreads are terrifying. To reduce spreads and activate trading, the issuer (the creator of the coin) or the exchange can hire a market maker. At the same time, they can specify the desired starting price of the token themselves or entrust its calculation to the market maker's analysts.
Let's suppose that the target price is $50. Then the market maker will place two orders with a small spread, for example, $49.95 to buy Thebestcoachever and $50.05 to sell it, which will launch trading on the market. Everyone who wants to buy or sell a token will conduct a transaction with a market maker. When the volume of trade grows, the issuer will allow the price to form due to the law of supply and demand, only occasionally intervening in the market and smoothing out high peaks or strong drawdowns.
What's at stake?
Market makers work on the principle «Buy cheap, sell expensive». It sounds primitive, if you do not take into account that trading on some instruments during busy hours goes at a speed of tens of thousands operations per second.
To keep up with such a crazy pace of trading, market makers use special algorithmic programs that track hundreds of parameters and recalculate forecast prices many times per second. This allows, on the one hand, to give liquidity to the market, and on the other not to go bankrupt.
But even complex trading robots do not always help: sometimes trades go too fast, which is why they do not have time for calculations, and sometimes the algorithm is wrong with the direction of the price. Plus, during strong volatility, the market maker often tries to extinguish it, which is why he, in fact, burns money.
Therefore, the best market for a market maker is a sideways hated by all traders, when the price fluctuates slightly near one level, or a gradual decrease or increase in price. But days with strong movements, on the contrary, can drive a market maker into a serious loss.
🪙 Ensuring price stability
Before you start laughing, let's explain that we are not talking about a fixed value of cryptocurrencies (we are not talking about USDT right now), but about a more or less stable spread. The market maker must keep it within the limits specified in the contract with the exchange most of the time. Of course, in case of extreme situations, for example, with a sharp rise or fall in the value of a coin due to news, the spread may expand, but this should be the exception, not the rule.
In addition, in the stock market, the market maker controls the price itself. He does not allow it to change too quickly, smoothing out jumps due to the mass buyout of orders.
That is, if the price of an asset has started to rise sharply, the market maker will redistribute the daily liquidity so as to try to buy back this increase and prevent the asset from shooting up. This is necessary to cut off speculative attempts to manipulate the market from real movements.
🤝 Market maker as a mediator
Big players do not always want to play on the stock exchange and influence prices. Sometimes they just need to buy an asset for long-term investment or sell a large amount of cryptocurrency at a more or less stable price.
They can do it on their own, for this they need to track prices and enter small orders. But it is difficult and long. Therefore, in such cases, a large buyer or seller usually comes directly to the market maker, bypassing the market. He helps to conduct an over-the-counter transaction for a certain commission. For example, a market maker can use the client's assets for their daily trading.
What do market makers earn from
Market makers are special players on the stock exchange. Unlike other market participants, they earn not only on the growth of the asset. More precisely, asset growth is not the main source of their income. They make a profit in other ways as well:
📊 Spread. Although the difference between the price of buying and selling cryptocurrencies may be minuscule, the spread gives very significant earnings with large trading volumes.
💵 Payment for services. Exchanges or cryptocurrency developers who want to support trading with their coin usually hire market makers or sign a contract with them. Theoretically, a developer can create trading activity himself, but this is an exceptional rarity as he must have a lot of capital, a strategy and a complex algorithmic trading robot for this. Sometimes payment can be indirect — in the form of discounts from the exchange commission or bonuses.
🤏 Commission for mediation. For each over-the-counter transaction, the market maker receives a percentage of it as payment.
In addition, during trading, market makers additionally receive invaluable information from the exchange (we'll tell you about it later), which allows them to receive a large income with arbitrage, usually using other exchanges. But excesses also happen. Details are below.
Arbitrage is the concurrent purchase and sale of the same asset on different markets in order to profit from little price differences. A good example is the current gas crisis in Europe. Now a huge number of gas carriers are standing around the EU ports and waiting for unloading. This is a lot of small (and big) players trying to make money on the price difference: they bought cheap gas in the USA and brought it to Europe, where it costs ten times more. There is also often a slight difference in price on different cryptocurrency exchanges. But with a large transaction volume, it can bring huge profits.
What is the difference between market makers on the stock market and in crypto
The main difference, from which all the other features of market makers on the crypto exchange follow, is the lack of regulation. In the stock market, a market maker is a mandatory element, a player whose activities are subject to a whole bunch of regulatory documents. They establish the rights and obligations of the liquidity provider, as well as determine its responsibility for the misuse of its capabilities.
And this responsibility is serious, often penal, because the market maker has huge opportunities to manipulate the market. Without «crutches» in the form of special legislation, few people will be able to avoid the temptation to use them.
If the official market maker on the cryptocurrency market misuses its capabilities, then it is in little trouble. Even if the violation happened head-on, the exchange is more likely to break the contract and try to settle everything under the carpet than go to court, since the lawsuit will cause huge damage to its reputation. Not to mention the fact that the exchange may be in collusion with the market maker.
A good example is the situation that is currently unfolding with the FTX exchange. The role of the market maker was performed by the Alameda company: it is a related party, 100% owned by the owner of the exchange. This opened up scope for misuse, up to the most primitive withdrawal of at least $4 billion of exchange customers (that is theft in fact) to close the financial hole in Alameda.
At the same time, those responsible are unlikely to incur significant penalties as the specifics of the crypto market allows you to find yourself in a distant warm country very quickly and with very big money.
How market makers manipulate the market
Ordinary participants of any market analyse its condition horizontally: they look at the history of price changes, look for patterns, support and resistance levels, and use indicators. They do everything to calculate entry and exit points that are likely to provide a profitable deal.
An example of horizontal market analysis.
Market makers run front and see the market vertically, they know all the characteristics of the Depth of Market (DOP): where pending orders are located, what Stop Losses and Take Profits are set for current transactions, how volumes are distributed.
An example of a market depth on the stock market. The market maker sees even more detailed data. Source: atas.net.
Simply put, ordinary market participants know what has already happened, and market makers know what will happen. In theory, this knowledge is needed to optimally set the purchase and sale prices, as well as to correctly define the volume of applications. But in practice, it can also be used to push the price in the appropriate direction for the market maker.
Stop Loss and Take Profit are exchange orders that are set by a trader for every specific transaction. They are both triggered automatically and contain an order to the broker to close a position when a certain price is reached. The difference is in the purpose: Stop Loss limits the trader's losses on the deal, and Take Profit allows them to fix in profits.
For example, a trader opens a purchase deal at the level of $20,000 per bitcoin based on its growth. To reduce their losses in case the price goes in the opposite direction, they can put a Stop Loss at the level of $19,500, and to fix the profit they can put a Take Profit at the level of $21,000.
Market manipulation schemes
Here is one of the schemes of how market makers move the price:
🔹 The market maker analyses the Depth of Market and determines the level at which a lot of Stop Losses have accumulated.
🔹 They evaluate the volume of pending orders (all orders of traders to buy/sell assets when they reach a certain price).
🔹 If the number of Stop Losses is large and the volume of counter orders is insignificant, then the market maker determines the level from which they need to push the price to enter the cluster of Stop Losses.
🔹 At the target level, they place a large order, the direction of which coincides with the direction of price movement (if the price goes down, then the order will be for sale, if up, then for purchase). When the price reaches this level, the order is triggered and pushes the price into the area of accumulation of Stop Losses.
🔹 The cascading triggering of Stop Losses ensures a sharp price movement, the market maker closes the deal with a huge profit, and crypto traders calculate losses.
It is difficult and unclear? Then we will give an example.
Imagine that you are a market maker and know in every detail the current Depth of Market for bitcoin on a major exchange. Let's say the price is gradually creeping up, and you see a lot of Stop Losses in the area of $20,000. At the same time, there are few buyers at this price.
In this case, you can enter the market with a large purchase volume at the level of $19,800-$19,900. You will buy out all counter orders (you know their volume), and the price will slip to the level of $20,000. Traders' Stop Losses trigger, bitcoin becomes more expensive by leaps and bounds, say, up to $20,300, and you close the deal, having received several hundred dollars of profit on each coin.
In theory, a market maker should protect against volatility, but you can't fight yourself, right?
Traces of a scheme with a breakdown of Stop Losses on the example of gold futures: a major player pushed the price down, collected pending orders for Stop Losses and the price continued to rise along the trend.
And there are many such schemes for manipulating the market. This is not only the breakdown of clusters with Stop Losses, but also the creation of false signals on the charts, the development of news, the introduction of their own news agenda.
Such methods are used even by official market makers in the regulated stock market: if you are not too greedy and calculate everything correctly, then it is almost impossible to prove the misuse of the position of a liquidity provider. There are only a few cases when market makers were caught by the hand, and all of them relied either on witness testimony or on wiretapping data.
Therefore, there is no need to talk about cryptocurrency «whales» as they really hunt for clusters with traders' Stops. But there are a few subtleties:
💯 Market makers are only interested in large accumulations of stop losses. If the immediate closing of orders does not provide a good price movement, then there is simply no point in doing this. And such clusters do not occur every day or even every week.
➡️ The market should really go against the trader if we are talking about popular cryptocurrencies. Rare market makers have enough liquidity to reverse the trend at least for a short time.
✊ Large crypto exchanges are trying to limit such activity in order to maintain customer loyalty. In this case, the lack of regulation is beneficial: the exchange can refuse service to any client, including the «whale».
So in practice, the amount of market manipulations is small. The vast majority of crypto traders with triggered Stop Losses and liquidated positions are victims of their own incorrect calculations and attempts to play against the market.
Liquidation or liquidated position is a situation when a trader's deal is closed by margin call. That happens when their account runs out of money to maintain the position, and the broker forcibly closes it.
The main crypto market makers
Official market makers who have a contract with some exchange have appeared on the crypto market quite recently. For example, this is a Cumberland trader who works with Binance. In addition, there is Jump Crypto, a department of the trading giant Jump Trading, which specializes in algorithmic and high-frequency strategies. But Jump Crypto is more focused on buying shares in cryptocurrency projects, so it cannot be called a classic market maker.
Also, the specifics of the cryptocurrency market turns any major player into a market maker. First of all, these are the creators of cryptocurrencies who own a huge number of coins. For example, bitcoin developer Satoshi Nakomoto, according to some estimates, may own more than one million BTC. This is more than 5% of all coins that can exist in the world. That is, Satoshi Nakamoto's condition allows him to manipulate the price of bitcoin in a very wide range, if he wants to.
The annual volume of transactions in the bitcoin network. Data for 2022 are current.
Finally, there are large investment funds that are interested in cryptocurrency to diversify their assets. Their financial capabilities are so huge that even a fraction of a percent of the capital is enough to significantly move the market. In particular, BlackRock, the world's largest investment fund that manages $10 trillion in assets, has already shown interest in cryptocurrencies. To compare: the volume of bitcoin trading for the whole of 2021 is only $13.1 trillion.
Market maker for a trader: friend, enemy, function?
Although in the last parts we wrote about such an unpleasant thing as market manipulation, in general, a market maker brings much more benefit than harm. It really creates a market:~
🔸 provides liquidity and volumes;
🔸 keeps the spread relatively stable and smooths out price fluctuations;
🔸 helps large players to make transactions outside the exchange so that they do not affect the rate.
Therefore, the market maker should not be considered as an enemy. Even if you've had your feet knocked out more than once. Even if it was very painful because of trading with the leverage. Even if it's Alameda from the FTX.
But a market maker is not a friend to a trader. Rather, it can be called a colleague or senior partner.