What is market maker?

A firm or program that continuously quotes both a buy and a sell price on a pair, earning the difference in return for keeping the book filled.

Market makers are why there is something to trade against when you press buy. On a centralized exchange they are trading firms running quoting software; on a decentralized exchange the same function is performed by an automated market maker contract and the people who supply it with capital. Exchanges court the firms with fee discounts, rebates, and formal programs with quoting obligations attached.

The misconception worth correcting is that a market maker sets the price. It does not. It quotes around wherever the wider market is, and its inventory risk is the reason its quote moves when the market does.

How it works

The firm posts a bid below the current mid price and an offer above it, both for a limited size. If both sides are hit in turn, it has bought low and sold high and captured the spread, minus fees and plus any maker rebate.

The risk is one-sided fills. If the price is falling, the firm's bids keep filling while its offers do not, and it accumulates inventory at prices above the new market. Managing that is the whole job. Firms hedge on other venues, widen the spread, or reduce the size they show.

Three variables move constantly: the width of the quote, the size at each level, and the skew between the two sides. A firm that expects the price to fall skews by quoting a wider bid and a tighter offer, which is what shows up in an order book imbalance.

On a decentralized exchange the same economics run through a formula instead of a firm. Liquidity providers deposit both assets, the contract quotes both sides automatically along a curve, and the providers earn the pool's fees while carrying impermanent loss in place of inventory risk.

Example

Illustrative round trip. A firm quotes a bid at $99.95 and an offer at $100.05 for 100 units each, a spread of 10 basis points. A retail seller hits the bid and a retail buyer takes the offer, both for 100 units.

The firm bought 100 units at $99.95 for $9,995 and sold 100 at $100.05 for $10,005, a gross of $10. At a maker rate of 0.01% on each side it pays about $2 in fees, leaving roughly $8. Done thousands of times a day, that is the business. Done once during a 5% price fall, the same firm is holding 100 units bought at $99.95 and now worth $95.

Why it matters when you buy

The spread you pay on any market order is a market maker's revenue. When makers withdraw, spreads widen and your fills get worse, which is why costs rise exactly during the volatility that made you want to trade. Venues with active market-making programs generally show tighter measured spreads, and the ranking on the liquidity pages reflects that directly.

Related terms

• maker rebate — how exchanges pay for quotes
• spread — the market maker's gross income
• automated market maker — the same role in code
• liquidity pool — where on-chain quoting capital sits
• market depth — the size their quotes create
• order book imbalance — visible skew in their quoting

Questions

Is a market maker trading against me?

It is taking the other side of your order, but it is not betting on your specific view. Its aim is to end the day flat, having earned the spread on volume rather than a directional move.

Why do spreads widen in a crash?

Inventory risk rises faster than the spread can compensate for, so firms widen quotes and cut size. Some withdraw entirely until they can price the risk again.

Do decentralized exchanges have market makers?

Yes, in a different form. An automated market maker contract quotes both sides from a formula, and the capital comes from liquidity providers who earn the fees and carry impermanent loss.