On October 11, the cryptocurrency market experienced a shocking scene once again, with major coins like Bitcoin (BTC) and Ethereum (ETH) plummeting significantly, while altcoins faced a complete rout with severe declines. Many analysts believe that the underlying reasons for this crash are not only the turmoil in macro sentiment and funding but may also be related to the "failure of market makers."

So, what exactly are market makers? What role do they play in the crypto market? And why do they "fail" at critical moments, causing the market to plummet? This article will delve into the mysterious and crucial "market maker" mechanism in the crypto space, starting from this recent crash.

In the cryptocurrency market, market makers are referred to as the "lubricants" of the market. Their main job is to continuously provide both buy (Bid) and sell (Ask) prices for a certain cryptocurrency on exchanges, ensuring smooth transactions. In simple terms, when ordinary investors want to buy or sell a certain coin, market makers are always the "present" buyers or sellers, ensuring that the market does not stagnate due to a lack of trading counterparts.

Therefore, providing liquidity is the primary task of market makers. Liquidity refers to the ability of an asset to be quickly bought or sold in the market without causing significant price fluctuations.

Secondly, market makers are also responsible for controlling spreads and stabilizing prices. They dynamically adjust their quoting ranges through algorithmic strategies, narrowing the bid-ask spread and reducing market uncertainty. When the market experiences severe fluctuations, market makers often use their asset scale and risk control models to prevent irrational price jumps, thereby playing a role in "smoothing the price curve" to some extent.

Although market makers bear the responsibility of maintaining market liquidity, they are not "charitable actors"—the fundamental driving force behind their operations comes from a diversified profit source mechanism. Overall, the main profit sources for market makers can be divided into three categories: spread income, trading fee rebates, and quantitative strategy profits.

First, the core income comes from the bid-ask spread. Market makers simultaneously quote buy and sell prices in the market, for example, buying at $99 and selling at $101. When traders transact with them, market makers earn a $2 spread. Although this profit is small, due to frequent trading and large capital scale, it accumulates to form a stable income base.

Secondly, many crypto exchanges offer partial fee rebates to market makers to enhance liquidity, and even provide additional rewards to encourage them to continuously provide deep quotes. This allows market makers to operate at a lower cost in high-frequency trading.

Finally, some professional market makers also use quantitative trading strategies to obtain additional profits. For example, through cross-exchange arbitrage (exploiting price differences between different platforms), statistical arbitrage, or algorithmic hedging, they can capture subtle profits amid market fluctuations.

To put it metaphorically, market makers are like large supermarket wholesalers: they earn money from the "difference between purchase and selling prices," benefit from supplier (exchange) rebate policies, and can earn extra profits through flexible pricing and inventory management.

In the crypto market, the role of market makers varies depending on the type of exchange. Centralized exchanges (CEX) rely on professional institutions or internal teams to actively place orders and provide liquidity. They can flexibly adjust buy and sell quotes based on market conditions, control positions, and utilize leverage strategies to maintain price stability and market order.

In contrast, decentralized exchanges (DEX) primarily rely on algorithms to automatically adjust liquidity, with user-deposited tokens forming liquidity pools (LP). Prices are automatically calculated by smart contract formulas, and market makers cannot actively withdraw orders or adjust prices.

In summary, CEX market makers ensure market liquidity through professional operations but rely on centralized institutions; DEX market makers achieve decentralization through algorithms and liquidity pools but have relatively weaker risk resistance in the face of severe fluctuations.

Regardless of their size, market makers always have limited capital, and they typically concentrate their main liquidity on major coins like Bitcoin and Ethereum, while their support for small and medium-sized altcoins is relatively weak. When the market experiences severe fluctuations, market makers cannot provide sufficient liquidity in a timely manner, leading to a cliff-like drop in the prices of these altcoins. For example, tokens like IOTX nearly went to zero during this crash, becoming a typical case of liquidity exhaustion.

Moreover, this crash occurred on a Friday night (early Saturday morning in Asia), when trading activity decreased and market makers had limited manpower, preventing them from promptly repairing the market liquidity gap, further exacerbating the market collapse.

Even more fatal was the decoupling of USDe and its associated high-leverage circular lending system. Within hours, the price of USDe deviated from its dollar peg, and many investors relying on USDe for circular lending were passively liquidated. Since many market makers also used USDe as contract collateral, when its value approached a halving in a short time, even low-leverage positions faced liquidation risks. The prices of small coin contracts and USDe formed a "chain reaction," resulting in significant losses for market makers.

If we view market makers as the "large supermarket wholesalers" of the market: they usually earn money from the bid-ask spread while smoothing prices and ensuring liquidity; exchanges act like suppliers, providing rebates and rewards to support operations. However, during the crash on October 11, the liquidity exhaustion of small coins, the decoupling of USDe, and high-leverage liquidations overwhelmed this "large supermarket," causing the market to collapse instantly. This serves as a reminder to investors that market liquidity is not infinite, and the risks at critical moments are often more deadly than surface fluctuations.

Related: Binance claims that tokens did not drop to $0 during the market crash, attributing it to a "display issue."

Original article: “The Invisible Force in the Crypto Trading Market: What Do Market Makers Really Do?”

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