Market Making in Crypto - Leverage the Highest Quality Data to Increase Your Outcomes

Are you engaged in market making in the cryptocurrency markets? Or maybe you just want to get started? In this article, we take a look at the main challenges market makers face in crypto and zoom in on the solutions.

What is market making in crypto?

Market making in crypto refers to the practice of providing liquidity to cryptocurrency exchanges by continuously offering to buy and sell crypto assets and ensuring there are always orders available at various price levels in the order book. Liquidity refers to the ease with which an asset can be bought or sold without causing a significant change in its price. Market makers provide this liquidity by:

• Placing limit orders on both sides of the order book (bids to buy and asks to sell)
• Maintaining a certain volume of orders at various price levels
• Quickly replenishing orders that get filled

Market makers commit to being active participants in the market at all times, even during periods of high volatility or low overall trading activity. This constant presence ensures that other traders can always find a counterparty for their trades. Market makers also help narrow the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask).

Why is it particularly important in crypto?

Some crypto markets lack liquidity and require market makers due to several factors:

1. Low trading volume
   In markets with few participants or infrequent trading, there may not be enough natural buyers and sellers to create a liquid market. This is often the case for:
   • New or niche cryptocurrencies
   • Illiquid trading pairs (e.g., minor crypto to minor crypto)
   • Markets during off-peak hours
2. Imbalance between supply and demand
   Sometimes there's a significant mismatch between those wanting to buy and those wanting to sell. This can lead to wide bid-ask spreads or difficulty in executing trades.
3. High volatility
   Some extremely volatile crypto markets can scare away regular traders, leading to reduced liquidity. Market makers help absorb some of this volatility.
4. Market fragmentation
   In crypto, there are multiple exchanges and trading platforms. This fragmentation can spread liquidity thin across multiple venues.
5. Lack of institutional participation
   Some markets, especially in crypto, may lack the participation of large institutional investors who typically bring significant liquidity.
6. Regulatory uncertainty
   Unclear or evolving regulations can deter some traders, reducing overall market participation.
7. Technical barriers
   Complex trading mechanisms or lack of user-friendly interfaces can limit participation, especially from retail traders.

Dependency between market makers and exchanges

Market makers typically cooperate closely (and formally) with crypto exchanges, and many exchanges do provide incentives or payment structures for market makers including lower fees and rebates. Some exchanges, especially in DeFi, offer their native tokens as rewards for providing liquidity.

Exchanges often provide specialized API and testing environment access to market makers, allowing for high-speed trading, real-time data feeds, and developing and refining their strategies. What is also important, crypto exchanges usually help market makers comply with regulatory requirements, which is crucial in such a highly regulated market.

How do market makers make money?

As we said before, market makers take advantage of rebates and fee discounts from cryptocurrency exchanges, as well as, token rewards in DeFi. However, it’s only part of their profits. The primary source of their income is bid-ask spread. It’s the difference between the highest price a buyer is willing to pay for an asset (the bid price) and the lowest price a seller is willing to accept (the ask price).

For example:

• Bid price (highest buy offer): $9,990
• Ask price (lowest sell offer): $10,010
• Bid-ask spread: $20 ($10,010 - $9,990)

Market makers consistently place both buy and sell orders in the market. They set their buy orders slightly below the current market price and their sell orders slightly above. When both their buy and sell orders are filled, they profit from the difference.

Furthermore, market makers use arbitrage trading strategies and profit from price discrepancies between different platforms by buying low on one exchange and selling high on another.

Main challenges of market makers in crypto

Data

Market makers face significant challenges and needs related mostly to cryptocurrency data. They require access to high-quality, real-time market insights from multiple crypto exchanges to inform their trading strategies and risk management.

Processing and analyzing vast amounts of data quickly is crucial, necessitating advanced data analytics and machine learning capabilities. Moreover, ensuring data integrity and dealing with inconsistencies across different sources pose ongoing challenges. Market makers also need historical data for backtesting strategies and developing predictive models.

Compliance

Crypto market makers also have to deal with diverse jurisdictions. They must contend with a fragmented global regulatory environment where approaches to cryptocurrency vary widely, from friendly to restrictive. Regulations often change or new ones appear, and sometimes they are simply missing.

Market makers must obtain various licenses, adhere to diverse AML/KYC requirements, and manage complex tax implications across borders. They also grapple with inconsistent asset classifications, unclear cross-border transaction rules, and emerging regulations in areas like DeFi.

Access

And yet another challenge is operating across numerous exchanges and trading pairs. Why does this pose a challenge? Because each exchange has its way of working, which means different trading rules, fees, ways to connect (APIs), and account types.

Market makers need to keep an eye on hundreds of crypto trading pairs and follow all prices, manage risk for each pair, and be able to move crypto and money between exchanges quickly. This in turn requires:

• Rapid connections to all exchanges
• Keep their systems running 24/7
• Run the software to automatically trade on many exchanges at once.

How market makers deal with the need for regulatory compliance

Market makers handle regulatory compliance through several key strategies. They build strong legal and compliance teams, implementing strict KYC/AML processes. They obtain necessary licenses in each jurisdiction and conduct regular self-audits.

Advanced technology helps them track and report trades as required. Staff training ensures everyone understands the rules. They often partner with compliance specialists and stay active in industry groups to keep up with changes. Clear internal policies guide their operations, supported by detailed record-keeping.

Regular communication with regulators helps them understand expectations. They carefully assess risks, adapt trading strategies to fit regulations, and vet exchanges for compliance. A global approach allows them to adjust to different countries' rules.

They aim for transparency when possible and plan for potential regulatory shifts. This comprehensive approach to compliance helps market makers avoid legal issues and contributes to building trust in the crypto market.

How does CoinAPI aid market makers in their daily operations?

The most accurate real-time and historical data

Market makers need access to real-time and historical data to make informed decisions. CoinAPI provides comprehensive data from over 350 exchanges and 10,000+ cryptocurrencies. Market makers can retrieve Open-High-Low-Close (OHLC) data, historical quotes, historical trades, and other kinds of crypto data which are essential for analyzing market trends and making trading decisions.

Besides, CoinAPI standardizes data collection, ensuring that market makers have a clean and complete view of the crypto market. They gain data ready to use.

Learn more about Market Data API

Order execution

Our EMS Trading API allows market makers to execute orders efficiently on multiple exchanges. It supports advanced order types and provides immediate execution, which is crucial for maintaining liquidity and managing risk. Thanks to this tool, market makers can automate their trading strategies which is crucial in increasing efficiency.

Learn more about EMS Trading API

Server redundancy

As a marker maker, you need to be sure that your software is working properly 24/7. Therefore, when establishing your application, always choose external providers who ensure redundancy.

For example, CoinAPI has multiple data centers located in different geographical regions, ready to replace each other in case of sudden errors, emergencies, and natural disasters. Having data centers closer to users in different regions, data can travel shorter distances, reducing latency and improving the speed and performance of the service.