Liquidity Providers & Market Makers: What You Need To Know

Liquidity Providers & Market Makers: What You Need To Know

In the trading industry, the question of which source to choose for your business is highly relevant due to liquidity’s crucial role in the market. Discussing this topic is currently ongoing. Both provide liquidity, but there are some significant distinctions between them. A brief understanding of both will help you recognize the better suit for your business and will motivate you to start detailed research.

First, Liquidity providers are financial corporations or institutions that assist brokers and exchanges with order execution. Offering bid and ask-prices allows service providers to fill orders efficiently and quickly. There are two categories of LPa in the FX market, Tier 1 and 2. Users that lock their assets into a “liquidity pool” and offer liquidity to the decentralized exchange platform in exchange for compensation in the form of LP tokens are known as liquidity providers in the crypto business. There are also traditional liquidity providers that provide access to pools of assets from major crypto trading platforms to smaller exchanges.

Second, Market makers are huge banks, funds, and entities with significant market power. They employ big sums of money and currencies to purchase and sell in large quantities to increase the liquidity of financial demands and ensure their correct operation. MMs trade on the stock market but may also operate in other industries, such as FX. Brokers who work under the DD (Dealing Desk) model profit by adjusting the bid-ask spread between the asset’s best bid and best ask prices, but expanding the spread might limit trading volume, raising the risk for MM.

Final Thoughts

Liquidity refers to the volume of trades on an exchange and is critical for the strength of any financial institution. High liquidity indicates that enough buyers and sellers can complete transactions swiftly and at market prices. In contrast, illiquid marketplaces make trading assets at their true worth difficult and can create buyer and seller discomfort. Low liquidity markets also create a dilemma in which a single transaction can majorly impact the entire market, making exchanges and their users vulnerable.