Order books do not fill themselves, and the firms that populate them operate under arrangements that shape how markets behave.
The basic business
Quoting both sides of a market and profiting from the spread.
Which requires managing inventory risk, since a market maker accumulates positions as it fills orders.
Hedging that inventory across venues and instruments is where much of the operational complexity sits.
Exchange incentives
Venues pay makers or charge them less than takers.
Which exists to attract resting liquidity.
Some venues offer additional rebates or fee holidays to designated market makers under contract.
Token issuer arrangements
Projects frequently engage market makers to provide liquidity for their token.
Which is done under two broad models.
Retainer models pay a fee for a service specification.
Loan and option models lend tokens to the market maker with call options at set prices, which has been criticised for misaligning incentives.
The option model problem
A market maker holding call options benefits from the token price reaching strike levels.
Which creates incentives that are not obviously aligned with the issuer or with holders.
Disclosure of these arrangements has been inconsistent and has attracted regulatory attention.
Spread determinants
Volatility, inventory risk, adverse selection and competition.
Which means spreads widen in volatile conditions precisely when liquidity is most wanted.
This is not withdrawal of service — it is the correct pricing of the risk being taken.
Latency and infrastructure
Colocation and connectivity matter, as in traditional markets.
Which advantages well-capitalised firms and is a normal feature of electronic markets.
Automated venues
Pool-based exchanges replace the market maker with a formula and a set of passive providers.
Which changes who bears the inventory risk, and it does not eliminate it.
What to look for
Depth at various price levels rather than reported volume, and how spreads behave during volatility.
These describe actual liquidity, which reported figures frequently do not.
Cross-venue operations
Firms quote on multiple venues simultaneously and manage aggregate inventory.
Which requires capital positioned across venues, since transfers take time.
Capital efficiency across fragmented venues is a persistent operational challenge.
Counterparty risk
Capital held on a venue is exposed to that venue.
Which has cost market makers substantially in past failures.
Off-exchange settlement arrangements, where collateral is held with a custodian and mirrored to the venue, developed in response.
Hedging instruments
Perpetual futures and options are used to manage directional exposure from inventory.
Which links spot and derivatives markets closely.
Funding rate costs are a direct input to how tightly a market can be quoted.
Regulatory position
Market making in regulated markets carries obligations regarding conduct and disclosure.
Which applies unevenly to digital asset venues depending on jurisdiction and venue status.
Enforcement actions regarding manipulation and undisclosed arrangements have occurred.
Assessing liquidity
Depth at specified distances from mid-price, and how it behaves during volatility.
Which is published by some venues and calculable from order book data.
Algorithmic quoting
Quotes are generated and updated continuously by systems responding to market conditions.
Which means spreads and depth change many times per second.
Risk limits built into these systems withdraw quotes automatically when conditions exceed parameters.
Inventory skew
A market maker holding excess of one asset will quote to encourage flow that reduces it.
Which appears as asymmetric quoting and is inventory management rather than a directional view.
Adverse selection
Being filled by counterparties with better information.
Which is the fundamental cost of providing liquidity and drives spread width.
It is why spreads widen ahead of anticipated news.
Disclosure practices
Arrangements between issuers and market makers are increasingly disclosed following criticism.
Which allows assessment of whether incentives are aligned.
Undisclosed option-based arrangements remain a documented concern.
What this means for participants
Liquidity is a service being provided at a price, and it withdraws when the price of providing it rises.
Assessing an issuer's arrangements
Whether market making is disclosed, on what terms and with what incentives.
Which some projects publish and most do not.
The absence of disclosure is itself informative.
Why it matters to ordinary participants
Execution quality depends entirely on who is quoting and under what conditions.
Which means the spread paid on a trade reflects the risk someone else is carrying.
Trading during periods of thin liquidity is measurably more expensive, and the cost is not always visible on the screen.
Regulatory direction
Disclosure requirements for issuer arrangements are being introduced in several frameworks.
Which addresses the main documented concern about undisclosed incentives.
Compliance with such requirements is a meaningful differentiator between issuers.
A closing observation
Liquidity is not a property of a market. It is a service someone is choosing to provide at a price, and it disappears when that price stops covering the risk.
Comparing venues
Order book depth at defined distances from mid-price is the measure that reflects actual tradeable liquidity.
Which several venues publish and which can be computed from public data on the rest.