TL;DR:
We already know that market makers play a key role in the efficiency, stability, and security of crypto markets. They develop strategies that help marketplaces stay open and competitive. Likewise, they help with price volatility, easier adoption, and the initial boost that’s needed to help new projects get off the ground.
Within crypto, however, market makers are not one-size-fits-all. They can play different roles and employ different strategies depending on which sector they’re in. At a very high level, we can observe different assumptions of market makers between centralized exchanges (CEXes) and decentralized exchanges (DEXes).
Let’s take a look at what this means and how they compare.
First, a quick recap on market makers. Whenever trades are being facilitated between various parties, there is usually someone who is in charge of providing the necessary liquidity to satisfy each market participant’s bid (to buy) or ask (to sell).
Say we have Alice, who needs X amount of asset A. We also have Bob, who is willing to trade Y amount of asset A in exchange for asset B. Theoretically, this should work; Alice wants asset A and Bob has asset A to sell. But what happens if Alice and Bob aren’t aligned on the price? A market maker would be a third party (we’ll call him Charlie) who is willing to satisfy both Alice and Bob’s requests by buying and selling what each of them needs.
In this scenario, Charlie acts as the market maker by offering to buy asset A from Alice at a price she finds acceptable and sell asset A to Bob for asset B at a price he finds acceptable. By stepping in as a neutral intermediary, Charlie helps establish a fair price that satisfies both parties. This ensures that the trade can take place, even if Alice and Bob have different opinions on the value of the assets involved. The market maker’s willingness to buy and sell assets provides liquidity and facilitates trading.
(For a more in-depth explanation, take a look at our previous post on the differences between Crypto Market Makers vs. TradFi Market Makers.)
Crypto is dominated by two general types of exchanges: centralized and decentralized. Both types of exchanges need market making to function, but each takes its own approach. When we compare market making on CEXes vs. DEXes, some patterns show up. Let’s take a look at how some of the key criteria stack up:
| CEXes | DEXes | |
| Exchange Structure | Centralized platform that relies on an intermediary (the exchange itself). | Decentralized protocol that facilitates peer-to-peer trading. |
| Model | A centralized order book system takes care of matching participants according to a bids-ask spread. | Usually, automated market makers (AMMs) run liquidity pools algorithmically to satisfy individual needs. |
| Control | At the end of the day, the company maintains control over order matching, order book management, and fee structures. This includes market makers, who are allowed or denied to participate by the company. | DEXes either are (or are on their way to being) governed by a community of token holders. DEXes provide autonomy to individuals. This includes market makers, who have the permissionless ability to provide liquidity should they choose. |
| Liquidity Sources | Liquidity comes from high-value partnerships with major market makers, or from their own in-house capital. | Liquidity comes from users who contribute funds to liquidity pools. This can range from small, individual liquidity providers or large, institutional market makers. |
| Access | Traders need to create an account and deposit funds into an exchange-owned account. This can result in geographic limitations. | Users can directly connect their cryptocurrency wallets and use the exchange non-custodially. |
| Speed and Fees | A centralized, server-based infrastructure allows CEXes to offer fast transactions. Fees to trade are often low, whereas fees to off-ramp to fiat are typically high. | Users and market makers are bound to the architecture of the underlying blockchain, which can result in slow speeds and high fees in times of network congestion. |
| Regulations | CEXes are subject to tighter regulatory requirements, and market makers adhere to specific compliance measures. | To date, crypto has operated in murky regulatory waters. Now, regulations like MiCA are providing clearer paths to compliance for DEXes and their market makers. |
To summarize: because of blockchain’s open architecture, Charlie’s role as a market maker can be fulfilled by anybody. Liquidity providers can range from small, retail DeFi users to large, institutional market makers. To these large market makers, DEXes provide the flexibility to provide liquidity to any token pair almost immediately. Theoretically, DEXes also have a broader total addressable market since they are available to “any” individual on earth.
However, DEXes also expose market makers to the downsides of blockchain technology in today’s ecosystem. Still-evolving networks can cause issues during periods of high congestion, resulting in slow transaction speeds and high fees. Historically unclear regulatory frameworks and nascent reporting tools have hindered innovation and made compliance trickier for both large and small liquidity providers.
On the other side of the coin, CEXes tightly control the role of market maker, typically working with a few select institutions to provide the capital needed to facilitate their order book. As is the history of centralized protocols, CEX users (and market makers) enjoy high throughput and low speeds. CEXes offer clean, consistent UI, attracting (today) a broader market of users that generate fees for those market makers. However, CEX market makers also confront the overhanging risk of, well, centralization. Security breaches of centralized servers can severely impact CEX operations.
Altogether, the story of market making for CEXes and DEXes mimics the broader experience of choosing between today’s worlds of centralization and decentralization. These choices boil down to sovereignty, security, cost, and efficiency.
It is not critical, however, for a market maker to choose between CEXes or DEXes. Each method of market making offers its benefits, and each will continue to evolve as regulation, user experience, and decentralized technology do.
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