How Market Makers Make Money on Ripple

traders

There are a variety of ways to make money on Ripple Photo: Rafael Matsunaga

When boiled down to its most fundamental nature, market making is about “buying cheaply and selling dearly.”

As we explored yesterday, algorithmic trading today dominates the market making landscaping. But that market has become saturated with competition and industry profits have been shrinking for the last five years. This has forced existing players to downsize and consolidate. And given market fragmentation, only firms with a large enough footprint can survive.

With the way things are today, there isn’t much room for a scrappy upstart to out-innovate the incumbents. The barriers of entry are simply too high—where it’s not just about having the smartest algos but also the most powerful systems and fastest connections.

New venues then, when it comes to market making, represent potential new opportunities due to inefficiencies that still exist in burgeoning markets. And in the case of Ripple, market makers play a key role in within the ecosystem.

So how do market makers make money on Ripple? With its distributed exchange, it’s not too different than anywhere else.

Bid-ask spread. This is classic market making. You buy an asset at one price, you sell it at another. In very liquid markets, you should be able to buy and sell relatively quickly so you don’t have to hold an asset for very long. The difference between the buy and sell price is known as the bid/ask spread. The higher the risk—for instance, if you aren’t sure you’ll be able to sell an asset you buy quickly—the higher the spread.

Directional plays. Ideally, a market maker can buy and sell at exactly the same time eliminating risk. But in many cases, they’ll have to hold inventory and can profit if the market moves favorably in their direction. In some cases, there might be an imbalance of flows, such as for certain remittance corridors, allowing market makers to profit by providing efficient liquidity.

Arbitrage. In developing markets such as Ripple, inefficiencies provide numerous opportunities for low risk profits between assets. Through an intimate understanding of the market’s structure, market makers can design algorithms to leverage these inefficiencies when they appear.

To learn more about Ripple, check out the Knowledge Center.

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