The financial sector frequently employs the phrases “liquidity provider” (LP) and “market maker” (MM) interchangeably. Both have decisive importance in supplying liquidity and maintaining the smooth operation of the trading system. However, certain differences between these two roles deserve further scrutiny.
What Is a Market Maker?
The smooth operation of capital markets is highly dependent on the presence of market makers, who maintain substantial liquidity and stable trading volumes. Market makers come in two main varieties: large-scale and speculative MMs. Both types serve an essential function in maintaining the health of the market.
Institutional MMs are subject to regulation by governing bodies and provide essential services to exchanges and trading infrastructures. They adhere to specific responsibilities outlined in their contracts. Conversely, speculative market-making firms operate in decentralised markets and willingly take on the function of MMs.
What Does Liquidity Provider Stand For?
A liquidity provider is a significant entity, usually a financial entity or a bank, offering vast securities or fiat currencies to the market to stimulate trading.
These participants may comprise well-established organisations such as banks and hedge funds, central banks, multinational corporations, retail speculators, and foreign investment project managers.
LPs function through electronic trading platforms, constantly providing bids and asking prices for all kinds of financial commodities. These prices are usually shown on the trading platforms of brokers or financial institutions that collaborate with a liquidity provider FX.
How Do They Differ?
LPs and MMs are decisive factors in worldwide markets. There are fundamental contrasts between them.
- Role and responsibilities
LPs engage in a very important activity in assuring optimal liquidity by offering quotes and filling orders that connect brokers to the interbank market. This helps to keep prices stable and promotes efficient trading. On the other hand, MMs are primarily accountable for creating markets for specific financial products by offering quotes using their own capital. They help execute trades and determine prices.
- Agreements and regulations
Aggregators or trading platforms have contractual agreements with LPs, which enable them to enter the market. LPs are responsible for maintaining market stability and are linked to regulatory control. Institutional MMs are also subject to regulation.
- Objectives and motivations
LPs are primarily motivated by the desire to enable trading and generate spreads. They gain income by carrying out many trades with small margins. On the other hand, MMs’ primary objective is to earn income from the spread by taking on market risk. They are exposed to more substantial price movements and may hold their positions for extended periods to increase their profits.
- Market exposure and trading volumes
Direct access to the foreign exchange market is granted to liquidity providers, which enables them to become involved in trading operations involving multiple currencies. On the other hand, market makers are confined to certain markets or instruments per their contracts’ terms.
Verdict
As a brokerage owner, it is essential to understand the significance of dependable LPs. These organisations are vital in ensuring stable and liquid markets, presenting traders with the best possible trading environment.
