Market makers vs. market takers: What’s the difference?

Market makers and market takers play an important role in ensuring that exchanges operate smoothly and efficiently. While one provides the liquidity required to allow an exchange to operate, the other makes use of that liquidity and helps keep the exchange moving as it should.

In this AAG Academy guide, we’ll explain what marker makers, designated market makers, and maker takers are in detail. We’ll also look at maker and taker fees and cover the advantages of both, as well as answer some frequently asked questions.

What are market makers?

Market makers are members of an exchange whose role is to buy and sell securities from their own accounts. They are often brokerage firms or banks that provide trading services and own a large inventory of a particular asset, including cryptocurrencies. However, market makers can also be individuals, some of which may be working on behalf of large institutions.

Market makers are committed to constantly quoting buy and sell prices, and to ensuring their assets are available throughout the trading day to facilitate trades when necessary. When an order is received from a buyer or a seller, they help ensure that the transaction can be executed by selling their own positions, or acquiring assets from other traders at the quoted prices.

A market maker’s primary function is to ensure there are always buyers and sellers in the market, which helps it run as smoothly and as efficiently as possible. They also help to stabilize prices. When there is excess supply of an asset, they will buy it to prevent its value from falling too low. When there is excess demand, they will sell to prevent prices rising too high.

Because they play such an important role, and are often appointed by stock exchanges and other financial institutions, market makers must adhere to strict parameters. They cannot take advantage of big market swings in the same way other traders can; they must remain disciplined and carry out their responsibilities to facilitate smooth transactions.

What is a designated market maker (DMM)?

Many exchanges use multiple market makers who compete against each other to offer the best buy and sell quotes across a variety of securities. However, others, such as the New York Stock Exchange (NYSE), use what’s called a designated market maker (DMM) system. These are lone market makers who control a particular security or group of securities.

DMMs operate in a similar fashion by posting buy and sell quotes according to strict parameters, however, they must adhere to even tighter controls and they operate from within the exchange itself. Some of their responsibilities are to ensure that the best price is always maintained, that all trades are executed, and that there is an orderly market.

At the beginning of each trading day, DMMs set the opening price for a security, which may be different to the closing price on the previous day due to events that have occurred after hours. Throughout the day, they buy and sell securities as required to ensure that prices are fair, and that the gap between “bids” and “asks” is as little as possible.

In finance, a bid is essentially the price a buyer is willing to pay for a particular security, while the ask is the price a seller is willing to accept. By narrowing the spread or difference between the two, DMMs, much like regular market makers, help ensure market stability and efficiency.

What are market takers?

Market takers are, in many ways, the opposite of market takers. While makers are working to ensure there is always liquidity in the market, a taker’s primary objective is to remove some of that liquidity by executing trades based on the prices that makers are offering. This allows them to carry out their moves more quickly than if they had to negotiate their own prices.

That doesn’t necessarily mean, however, that market makers are spoiling the efforts carried out by market makers. In fact, their role is also important as it helps ensure there is a constant supply of buyers and sellers in the market. Takers aren’t looking for the best possible prices; they are simply looking to trade, which again improves the health and efficiency of the market.

Market takers are typically individual investors, institutional investors, and hedge funds.

Market maker and taker fees explained

If you have ever purchased cryptocurrencies from an exchange, you may have noticed that there are often maker and taker fees. These are costs that occur when orders are placed and executed, and they are designed to incentivize makers into providing liquidity, which an exchange relies on to attract traders. Let’s look at them both in more detail.

Makers fees
When a maker creates a limit order, or quotes a buy and sell price, it gets added to the order book and provides the exchange with liquidity. In other words, the maker is creating a market and allowing others to make trades, so they receive a share of the fee that the taker pays when executing a market order.

In some cases, the maker may be charged a fee for placing an order, but they may also receive a transaction rebate for providing liquidity.

Taker fee
Takers place market orders, which are essentially instant trades executed at the best possible price. These are different to market orders, in which the market maker or trader specifies both the price and quantity of the security they want to buy or sell. As a result, takers are removing orders from the order book, or removing liquidity from the market.

The fee for this type of trade is typically higher because it is in the exchange’s best interests to minimize the frequency at which market orders take place.

Advantages of market makers and takers

As we’ve outlined above, the biggest advantage of makers is that they provide liquidity. This not only attracts traders to an exchange, but it also ensures that they can execute the traders they wish to make at the right price. They play an incredibly important role in ensuring an exchange can operate effectively and efficiently.

The biggest advantage of takers is that they contribute to an active market and keep everything moving as it should. If you’ve ever placed a market order on an exchange, or fulfilled someone else’s limit order, then you’ve been a taker at some point.

References

• Marketmaker
• Who are market makers healthy markets
• What are makers and takers
• What are maker fees and taker fees for cryptocurrency traders