Market maker

Short description: Financial markets term

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A market maker (also called a liquidity provider) is a firm or individual that quotes both a buy and a sell price for a financial instrument and stands ready to trade at those quotes, profiting on the difference between the prices, known as the bid–ask spread.[1] By committing capital to hold inventory and continuously posting quotes, market makers supply market liquidity, enabling other participants to transact on demand and contributing to price discovery.[2]

Market makers operate across stock exchanges, over-the-counter markets, and electronic trading venues, taking various institutional forms: designated specialists at the New York Stock Exchange, competing market makers at Nasdaq, official market makers on the London Stock Exchange under the SEAQ system, and "designated sponsors" at German exchanges.[2] In return for quoting obligations, official market makers typically receive trading privileges and informational access not granted to ordinary participants.[3]

In decentralized markets such as cryptocurrency protocols, the role of the traditional market maker is performed by automated market maker algorithms and pooled-liquidity contracts; participants who deposit assets to such pools earn fees from trades that execute against them.[4] Market making in both traditional and decentralized venues has been the subject of post-2008 regulation aimed at separating intermediation from proprietary trading within deposit-taking banks.[5][6]

## Contents

* 1 History
* 2 Mechanics
* 3 In equity markets
* 3.1 United States
* 3.2 United Kingdom
* 3.3 Germany
* 3.4 Japan
* 4 In foreign exchange and derivatives
* 5 Automated market makers
* 6 Regulation
* 7 See also
* 8 References
* 9 External links

## History

Market making originates in the role of jobbers on the London Stock Exchange and of specialists on the New York Stock Exchange, each of whom held exclusive trading rights in designated securities and supplied two-sided quotes to broker counterparties. The Big Bang reforms of 1986 ended the broker–jobber separation on the LSE and opened market making to integrated firms, while specialists at the NYSE were progressively replaced by designated market makers (DMMs) following the introduction of electronic quoting systems in the 2000s.[7] Theoretical study of market making advanced in parallel: a foundational 1985 paper by Lawrence Glosten and Paul Milgrom showed that, in a market where some traders may hold private information, the equilibrium bid–ask spread compensates the market maker for the adverse selection risk of trading with informed counterparties.[8]

## Mechanics

A market maker quotes a bid (the price at which it will buy) and an ask or offer (the price at which it will sell) for a given quantity of a financial instrument. The spread between bid and ask is the principal source of market-maker revenue: if buy and sell orders arrive in equal volume and the mid-price does not move, the firm earns the full spread on each pair of round-trip trades.[1] Market-microstructure research decomposes the realized spread into three components: an order-processing cost, an inventory-holding cost, and an adverse-selection cost arising from trades against better-informed counterparties.[9][8] In practice, market makers manage inventory risk when one-sided order flow leaves them long or short of the instrument, and they widen quotes or hedge with related securities when volatility rises.[3][7]

In addition to spread capture, market makers may receive payments, rebates, or commissions for executing client flow.[3] They are also typically permitted to use naked short selling within defined limits as part of their quoting obligations, although general naked shorting by ordinary participants was prohibited in the United States in 2009 and the European Union imposed a permanent ban on naked credit default swap positions in 2011.[10][11]

## In equity markets

### United States

On the New York Stock Exchange and the NYSE American, designated market makers (DMMs), previously known as "specialists", act as the official market maker for each listed security, supplying a defined level of liquidity and taking the other side of trades when short-term order imbalances appear. In return, they receive informational and execution privileges set by exchange rules.[2]

NASDAQ instead operates with multiple competing market makers in each security; they are required to maintain two-sided quotes during exchange hours and to honor the bids and offers they display.[2] The U.S. Securities and Exchange Commission defines a "market maker" as a firm that stands ready to buy and sell stock on a regular and continuous basis at a publicly quoted price, and the CBOE operates a related Designated Primary Market Maker (DPM) program for options.[2][12]

Listed United States market-making firms include Citadel Securities, Virtu Financial, Jane Street Capital, Optiver, IMC, and Flow Traders, several of which appear on the European Securities and Markets Authority list of authorised market makers under Regulation (EU) No 236/2012.[13]

### United Kingdom

On the London Stock Exchange, member firms that take on a quoting obligation become official market makers for a security. Their two-sided quotes appear on the Stock Exchange Automated Quotation system and are visible to brokers acting on behalf of clients. Each stock has at least two official market makers, who are obliged to deal at their displayed prices.[1]

Before the Big Bang reforms of 1986, market making on the LSE was the exclusive function of jobbers, who traded with member brokers but not directly with the public. The reform allowed integrated firms to combine the broker and jobber roles. Active UK market-making firms after Big Bang have included Peel Hunt, Winterflood Securities, Liberum Capital, and Shore Capital.

### Germany

At the Frankfurt Stock Exchange, the role of the market maker is performed by "designated sponsors", appointed by listed companies to provide binding two-sided quotes for their shares on the Xetra electronic-trading system. Designated sponsors are required to meet minimum quote-presence and maximum-spread parameters set by the exchange.[14][15][16]

### Japan

The Tokyo Stock Exchange introduced an ETF Market Making Incentive Scheme in 2018, which provides fee rebates and other incentives to firms that maintain qualifying quotes in eligible exchange-traded funds. Listed scheme participants have included Nomura Securities, Flow Traders, and Optiver.[17]

## In foreign exchange and derivatives

Most foreign-exchange dealing firms and many banks act as market makers, quoting two-sided prices in currency pairs and earning the spread on client trades.[1] Derivatives exchanges including the Chicago Mercantile Exchange, Eurex, and the CBOE operate designated market-maker programs in options and futures, with quoting obligations and corresponding fee benefits set out in exchange rulebooks.

## Automated market makers

In decentralized finance, an automated market maker (AMM) is a smart-contract program that holds pooled reserves of two or more assets and continuously offers to trade between them at prices determined by a deterministic pricing function, most commonly a constant-product formula in which the product of the reserves remains invariant.[4] Liquidity providers deposit assets into the pool and receive a share of trading fees; in contrast to traditional market makers, they do not actively quote and bear the risk of impermanent loss when reserve prices diverge from external markets.[4]

A separate strand of automated market making originates in academic prediction-market design: liquidity-sensitive scoring rules such as the logarithmic market scoring rule allow algorithmic market makers to provide continuous quotes for thinly traded contingent claims while bounding the operator's worst-case loss.[18]

Because decentralized exchanges have no central operator with jurisdictional reach, government enforcement of trading or disclosure rules against AMM protocols has been a recurring policy challenge.[19]

## Regulation

Following the 2007–2008 financial crisis, regulators sought to separate intermediation activity from proprietary risk-taking within deposit-taking banks. In the United States, the Volcker Rule (section 619 of the Dodd–Frank Wall Street Reform and Consumer Protection Act) restricts insured depository institutions from short-term proprietary trading but preserves explicit exemptions for market making, underwriting, and risk-mitigating hedging.[6] In the United Kingdom, the Independent Commission on Banking, chaired by Sir John Vickers, recommended a structural ring-fence under which market-making and other investment-banking activities sit outside the retail-banking perimeter at large UK banks; the recommendation was implemented through the Financial Services (Banking Reform) Act 2013.[5]

In the European Union, short-selling and market-making activity is governed by Regulation (EU) No 236/2012, under which firms must notify the relevant competent authority before relying on the market-making exemption from short-selling restrictions, and the European Securities and Markets Authority maintains a public register of authorised market makers and primary dealers.[20]

## See also

* Automated market maker
* Bid–ask spread
* Market liquidity
* Market microstructure
* Sales and trading
* Stockjobber

## References

1. ↑ 1.0 1.1 1.2 1.3 Radcliffe, Robert C. (1997). Investment: Concepts, Analysis, Strategy. Addison-Wesley Educational Publishers. p. 134. ISBN 0-673-99988-2.
2. ↑ 2.0 2.1 2.2 2.3 2.4 "Market Makers". https://www.sec.gov/answers/mktmaker.htm.
3. ↑ 3.0 3.1 3.2 Aldridge, Irene (April 2013). High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems. John Wiley & Sons. ISBN 978-1-118-41682-2. https://books.google.com/books?id=8QpIsVUMhmEC&pg=PT167.
4. ↑ 4.0 4.1 4.2 Borri, Nicola; Shakhnov, Kirill (2023). "Cryptomarket discounts". Journal of International Money and Finance 139. doi:10.1016/j.jimonfin.2023.102963.
5. ↑ 5.0 5.1 Prudential Regulation Authority (September 2020). ﻿Proprietary Trading Review﻿ (Report). Bank of England. https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/report/proprietary-trading-review-2020.pdf. Retrieved May 12, 2026.
6. ↑ 6.0 6.1 "Agencies issue final rules implementing the Volcker Rule" (Press release). Board of Governors of the Federal Reserve System. December 10, 2013. Retrieved May 12, 2026.
7. ↑ 7.0 7.1 Harris, Larry (2003). Trading and Exchanges: Market Microstructure for Practitioners. Oxford University Press. ISBN 0-19-514470-8.
8. ↑ 8.0 8.1 Glosten, Lawrence R.; Milgrom, Paul R. (1985). "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders". Journal of Financial Economics 14 (1): 71–100. doi:10.1016/0304-405X(85)90044-3.
9. ↑ Madhavan, Ananth (2000). "Market microstructure: A survey". Journal of Financial Markets 3 (3): 205–258. doi:10.1016/S1386-4181(00)00007-0.
10. ↑ "'Naked' short-selling ban now permanent". NBC News. Associated Press. July 27, 2009. https://www.nbcnews.com/id/wbna32174335.
11. ↑ Barker, Alex (October 19, 2011). "EU ban on 'naked' CDS to become permanent". Financial Times. https://www.ft.com/content/cc9c5050-f96f-11e0-bf8f-00144feab49a.
12. ↑ "Designated Primary Market Maker (DPM) Program Info". https://www.cboe.com/about/.
13. ↑ "List of market makers and authorised primary dealers". European Securities and Markets Authority. https://www.esma.europa.eu/databases-library/registers-and-data/short-selling/list-of-market-makers-and-authorised-primary-dealers.
14. ↑ "Designated Sponsors". Deutsche Börse Xetra. https://www.xetra.com/xetra-en/trading/admission-and-membership/designated-sponsors.
15. ↑ "Designated Sponsor and Market Maker: Liquidity through Designated Sponsors". https://www.cashmarket.deutsche-boerse.com/cash-en/trading/Xetra/Designated-Sponsor-and-Market-Maker.
16. ↑ "Designated sponsor" (in en). Stock Exchange Glossary. Deutsche Börse Group. 22 November 2018.
17. ↑ "JPX ETF Market Making Incentive Scheme". Japan Exchange Group. https://www.jpx.co.jp/english/equities/products/etfs/market-making/.
18. ↑ Othman, Abraham; Sandholm, Tuomas; Pennock, David; Reeves, Daniel. "A Practical Liquidity-Sensitive Automated Market Maker". Harvard University. http://www.eecs.harvard.edu/cs286r/courses/fall12/papers/OPRS10.pdf.
19. ↑ Croman, Kyle; Decker, Christian; Eyal, Ittay; Gencer, Adem Efe; Juels, Ari (2016). "On Scaling Decentralized Blockchains: (A Position Paper)". Financial Cryptography and Data Security. Lecture Notes in Computer Science. 9604. Springer. pp. 106–125. doi:10.1007/978-3-662-53357-4_8. ISBN 978-3-662-53356-7. https://link.springer.com/chapter/10.1007/978-3-662-53357-4_8.
20. ↑ "List of market makers and authorised primary dealers". European Securities and Markets Authority. https://www.esma.europa.eu/databases-library/registers-and-data/short-selling/list-of-market-makers-and-authorised-primary-dealers.

## External links

* Understanding Derivatives: Markets and Infrastructure – Chapter 1 Federal Reserve Bank of Chicago

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