Market Makers & Liquidity Providers Explained

Many discussions are in progress in the trading industry since liquidity plays a characterized role in the market, and the main question is always relevant: which source should I select for my business? Liquidity providers and market makers are two categories of financial intermediaries who play major roles in global financial markets. Both provide liquidity, but there are several major differences between them.

Liquidity refers to the volume of trades on an exchange and is critical for the strength of any financial market. High liquidity indicates that enough buyers and sellers are available to 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.

• MM: Market makers are influential financial market players, including major banks, funds, and institutions. They aim to increase liquidity and ensure proper market functioning by trading large amounts of money and currencies. While stock markets are the most common market for market makers, they also trade in other markets, such as Forex. Brokers in the Forex market who work under the DD model are referred to as market makers and generate revenue by manipulating the bid-ask spread. However, widening the spread can result in reduced trading activity and increased risk for market makers.

• LP: Financial firms or institutions that help brokers and exchanges execute orders are known as liquidity providers. There are two kinds of liquidity providers in the Forex market: Tier 1 and Tier 2. Liquidity providers in the crypto business lock their assets into a "liquidity pool" and offer liquidity to the decentralized exchange platform in exchange for LP token incentives. There are also traditional liquidity providers that provide access to asset pools from major crypto trading platforms to smaller exchanges.

In summary, Liquidity is essential for any financial market, and both market makers and liquidity providers offer an important service to the markets. Market makers facilitate trades between buyers and sellers, while liquidity providers supply large amounts of assets to ensure smooth price movements and reduce volatility. Both roles are important for ensuring efficient trading and a healthy market.