Basics of marketmaking
Market making is a trading strategy that involves continuously buying and selling securities or assets in order to profit from the spread between the bid and ask prices. This strategy is used by traders and firms to provide liquidity to the market, allowing buyers and sellers to execute their trades more efficiently. The role of a market maker is crucial to the functioning of the cryptocurrency market, as they help to provide a steady flow of buy and sell orders, which can help to reduce volatility and ensure that prices remain stable.
In DeFi, marketmaking is often done through automated market makers (AMMs), which use smart contracts to facilitate trades between different assets. Market makers can provide liquidity to AMMs by depositing assets into liquidity pools, where they earn trading fees in proportion to their share of the pool. Market makers can also use sophisticated algorithms to optimize their trading strategies and minimize risk, such as by hedging against market volatility or executing trades across multiple exchanges.
AMMs use a mathematical formula to determine the price of a particular asset based on the ratio of the assets in a liquidity pool. This means that the price of the asset can change as the pool's liquidity changes. In contrast to AMMs, Central Limit Order Books (CLOBs) use a traditional order book model where buyers and sellers place limit orders specifying the price and quantity of the assets they want to buy or sell. In the context of market making, CLOBs play a key role in providing liquidity and price discovery for different assets.
CLOBs are typically used by traditional market makers, who use sophisticated algorithms and trading strategies to manage their portfolios and execute trades. These market makers may charge a service fee for their services, as well as higher token allocations and a more centralized model of engagement.
In DeFi, CLOBs can also be used to provide liquidity and price discovery for different assets, such as through the integration of decentralized exchanges with existing centralized trading platforms.
Centralized exchanges (CEXs) play a significant role in market making as they serve as a platform for buyers and sellers to trade different assets at a specific price. CEXs typically charge a fee for their services, and market makers on these platforms may charge additional fees for their marketmaking services.
CEXs offer several advantages, including faster transaction times, greater liquidity, and more diverse trading pairs. This makes them a popular choice for many traders and investors, particularly those who require access to large amounts of liquidity or are trading high-value assets.