Explaining Market Makers and Takers
In the world of trading, two types of participants exist: makers and takers. Makers initiate buying or selling orders that do not execute immediately, such as a directive to "sell BTC when the price hits $50k." This results in liquidity, making it simpler for others to purchase or sell BTC promptly once the price condition is met. Takers are the individuals who buy or sell instantly and fulfill the orders produced by makers. Essentially, the takers execute the orders created by makers, resulting in a seamless market.
Matching sellers with buyers is a crucial aspect of any exchange, be it for stocks or cryptocurrencies. Without these connection points, you would have to advertise your desire to trade Bitcoin for Ethereum on social media and wait for someone to take an interest.
This piece explores the concept of makers and takers straightforwardly. Every individual involved in a market can be categorized as one or the other, and, as a trader, you may act in both roles at some point. The existence of makers and takers is what keeps many trading platforms running and can distinguish a robust exchange from a feeble one
What Is Liquidity?
To fully comprehend the concepts of makers and takers, we must first understand liquidity. The term "liquidity" refers to how easily an asset can be sold, and it is used to describe the tradeability of an asset.
For instance, an ounce of gold is considered a highly liquid asset since it can be sold for cash quickly. In contrast, a ten-meter statue of Elon Musk riding a bull is an illiquid asset since it would be difficult to find a buyer interested in acquiring it.
Market liquidity is a related yet distinct idea. A market with high liquidity enables the easy buying and selling of assets at a reasonable price. There is a great demand from buyers interested in acquiring the asset, and a high supply from sellers wanting to offload it. This level of activity leads to buyers and sellers meeting in the middle, and the difference between the highest bid and the lowest ask prices being small or "tight". This difference between the bid and ask prices is called the bid-ask spread.
On the other hand, an illiquid market lacks these characteristics. If an asset is sold in such a market, it may not fetch a fair price due to the lack of demand. As a result, an illiquid market usually has a much higher bid-ask spread.
Who Are Market Makers and Takers?
When traders use an exchange, they act as either makers or takers. An exchange calculates the market value of an asset with an order book, where all the offers to buy and sell from its users are collected. A maker adds their order to the order book, such as "Buy 420 BTC at $6,000," and waits for the price to reach $6,000. By adding their inventory to the exchange, makers make the market. Big traders and institutions often act as market makers, but small traders can become makers by placing certain order types that aren't executed immediately.
A taker, on the other hand, removes part of the liquidity of the exchange by taking advantage of the inventory placed by makers. A taker places an offer on the order book and immediately fills existing orders using a market order or a limit order. Anyone who fills someone else's order is considered a taker, whether they use a market or limit order. It's important to note that using a limit order does not guarantee a maker order. If a trader wants to ensure their order goes into the order book before being filled, they need to select "Post only" when placing their order.
The maker-taker fee structure is an essential component of most exchanges' revenue generation model. These fees are charged every time an order is executed, and they can vary depending on the exchange, the trading size, and the user's role.
Usually, makers receive a rebate as they bring liquidity to the exchange, making the platform more attractive to potential traders. In contrast, takers may be charged higher fees as they don't add liquidity to the market. However, the fee structure is subject to the exchange's policies, and the maker-taker roles may be reversed or eliminated on some platforms. Ultimately, the fee structure can impact trading volume, so exchanges need to strike the right balance between incentivizing makers and generating revenue.
The two types of traders on exchanges are makers, who create orders and wait for them to be filled, and takers, who fill someone else’s orders. The primary role of makers is to provide liquidity to the exchange, making them critical to the exchange's appeal. Therefore, in a maker-taker model, exchanges offer makers lower fees to incentivize them. On the other hand, takers take advantage of the liquidity provided by makers to buy or sell assets easily, but they typically pay higher fees.