Understanding Market Makers and Market Takers
There are two key participants in any securities market: market makers and market takers.
The market maker is the party that places an order to buy or sell a security at a quoted price, while the market taker is the party that accepts and executes the order at the quoted price.
Traditionally, crypto exchanges, including early decentralized exchanges (DEXs), followed the order book model, where makers would place buy and sell orders that takers could accept and execute.
Market Makers and Market Takers in Trading
Market makers are crucial in providing liquidity and depth to the markets.
They aim to profit from the spread difference between bid and ask prices or predict price movements during market volatility.
On the other hand, market takers rely on this liquidity and immediate execution to enter or exit positions swiftly.
Due to the differing motivations of makers and takers, with makers seeking profits from market conditions and spread differences, while takers prioritize quick transactions, there are typically more makers than takers in the market.
Makers tend to trade more frequently and at higher volumes compared to takers.
Liquidity Challenges in Early Decentralized Exchanges
Many centralized exchanges act as market makers, providing liquidity and depth to attract takers.
This leads to increased trading volume and liquidity, further attracting more makers to contribute their liquidity to the market.
The success of this model posed challenges for early DEXs in attracting liquidity to decentralized markets.
The volume and competitive prices necessary to entice takers were lacking without sufficient makers providing liquidity and depth.
Without takers, makers had little incentive to provide liquidity when they could easily trade on centralized markets.
Modern DEXs addressed this liquidity issue by implementing the automated market maker (AMM) model.
This model overcomes the liquidity challenge by utilizing algorithms and liquidity pools to facilitate trading, eliminating the reliance on order books.