They are describing this from the perspective of an exchange however. Also most of the initial guys came from Jane Street which is a market maker. While I haven't personally worked at a market maker before, I suspect these guys are less fascinated by crytpocurrencies themselves but by how there is suddenly a whole new class of assets that is ballooning and ripe for market makers. As market makers, they are also understandably less concerned about what an underlying asset itself really is worth, or what it even is, but more about facilitating transactions and arbitraging away inefficiencies. (for example, in the podcast he repeats a few times, "who are we to question what it's worth if the markets have spoken"). So from that perspective I can sort of understand why he described it that way.
A lot of people support "market making", but then talk about frontrunning trades in situations that are morally and technically equivalent to market making. Computer nerds tend to assume the role of "market maker" is more formally defined than it really is. Really, there are just liquidity sellers and liquidity buyers.
(I'm going to agree with your first sentence by disagreeing with everything you said about market making)
> Look at market making (providing liquidity for other traders). There's an intrinsic demand for liquidity from funds which try to manage an index, hedgers, and speculators. The goal of market making is to provide liquidity to facilitate those other traders. And yes, there's a small premium for the service, but the fact that the premium is shrinking over time reflects a lower cost for the rest of society.
I think that's a very quaint view of market makers, maybe valid 20 years ago but it seems disconnected from modern circumstances. Market making has largely become synonymous with algorithmic trading, which now accounts for somewhere between 25%-75% of traded volume (obviously varying widely between markets, see http://ftalphaville.ft.com/blog/2011/03/04/505021/algo-tradi...).
A significant subset of the prop traders have been spiraling into a latency arms race, which has gotten to this absurd point where even millisecond-scale trading is considered slow.
Regular old market making (put orders on both sides of the book, make profits from the spread) only seems to work in the absence of significant competition. In reality, profitable firms are running all sorts of short-term speculations and even trying to prey on the trading behavior of people & other algorithms. There have been all sorts of algo-induced pricing anomalies documented at http://www.nanex.net/FlashCrash/FlashCrashAnalysis.html.
The supposed benefit of all this nuttiness is improved liquidity, but I wonder: Who needs liquidity at the millisecond scale? What business, other than algorithmic speculation, will suffer if they have to wait 1/2 a second to buy or sell something?
Also, I question whether the premium of modern prop trading is actually small-- there are a large number of prop trading firms that seem to be doing extremely well for themselves. I don't know the specifics, but I wouldn't be surprised if the sum of prop trading profits reach high into the billions.
Furthermore, these companies siphon off a large number of smart grad students, who would have likely otherwise done something actually socially productive with their time.
The market makers do understand why they are trading and understand it has nothing to do with fundamental value. That may be your reason for trading. They are there to rapidly and correctly assess short term supply and demand so they can extract compensation for providing liquidity. And that’s a good thing. A market made of heterogenous actors with different objectives and time scales is far more robust.
"A market maker is merely a prop desk running a particulra strategy. They have no information on Goldman's clients. They behave exactly like any hedge fund."
The common understanding is that a market maker is not exactly a prop desk. The clients of a market maker are the counterparties who take the other side of the market maker's markets. (These counterparties are Goldman clients). Market makers are not hedge funds and don't fundamentally behave like hedge funds, though I suppose both during their line of work take views on markets, so there are some similarities.
My point was, market makers, by definition, know what (their) clients are doing and take market views based on this. The major value in being a market maker (which is a huge part of Goldman's capital markets business) is seeing client flow.
Ah okay thanks. I always just considered professional market makers (as described there) as just another kind of participant or counter-party who just has a particular strategy and maybe takes advantage of volume rebates or similar (but basically transparent) incentives to act as a liquidity provider.
But I see that you're making a comparison about bitcoin markets where that kind of structure is mostly not there.
That reminds me. For anyone interested, there's an interview with a HFT market-making guy here who set up the LXDX exchange for crypto derivatives and who talks a bit about the differences in market microstructure: https://www.youtube.com/watch?v=xkhLZXLb8mU
I like the analogy/idea, or more precisely find it amusing. But this company doesn't have the necessary liquidity. Plus I am not sure if there can be a real market maker given the transaction volume and volatility of BTC: In the past the daily transaction volume was in the 3 to 8 * 10^9 [billion] US$ range[1], which is massive. And the volatility isn't exactly famously tame either. For comparison, that company self-reports to have moved a mere 92 million in 5 years.
That's like someone with a 500k to 700k portfolio doing 1M worth of transactions in 5 years (should be reasonable?) trying to be market maker for Tesla.
I'm not so much interested in investing at all, but I'm fascinated by market structure details like these; it's like an Internet of money. It has extreme nerd value, regardless of its utility for profit seeking. :)
Also, the details in this article are implicated in all sorts of HN threads, so it's useful to have a place to link to when people start debating how market makers work or things like that.
Thanks, I'll watch the talk with I get a spare moment.
Regarding the existing opportunities, It's interesting imagining a situation where opportunities did not exist, seemingly the market would either become completely random, and driven by luck, or remarkably stable. Most interestingly it crazy to imagine a market that has been optimized to complete stability. I wonder if that's the natural progression of things.
> this idea could work very well in other types of property markets
Constantly offering to the market is market making. It's a difficult, risky and specialized domain in any asset classes. Most markets cannot support real-time market making for the simple reason that price discovery is expensive and intrinsically tied to liquidity.
A marketmaker is someone who stands ready to both buy and sell at some published price.
They're aggregating a deal which they are then reselling. That's more like a broker-dealer, I guess. Taking principal risk in what might eventually IPO is more of an underwriter.
Actual marketmakers tend to try to go home with no risk on the books, because they have no interest in exposing themselves to gap risk.
I think lots of people have casual understandings of what financial terms mean and then just sort of guess the rest of it (much like people think SecondMarket is the secondary market; it's not.)
I didn’t assume that of you at all, I actually had assumed the opposite and that you had experience in the area.
I agree it would be challenging to have deep and useful markets, but perhaps there’s more innovation to be made there — and many of these high level markets that are top of public consciousness I’d expect to have plenty of liquidity.
So much talent... focused on the buying and selling of securities, instead of creating new things that will make the world better in a directly measurable manner.
Virtually all trading volume today consists of buying and selling old securities -- essentially, legal claims on existing assets. The sale of new securities issued to finance the creation of new products and services -- for example, a company selling new shares via an IPO or issuing new bonds for investment in physical infrastructure -- represents only a minuscule portion of total trading volume.
I'm not sure having so many of our best and brightest minds going to Wall Street (and into high-frequency trading in particular) is a good thing, from a societal perspective.
--
PS. Whenever I read anything about high-frequency trading, I'm reminded of the following passage, written by John Maynard Keynes in 1936 -- 77 years ago (!): "Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of 'liquid' securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is 'to beat the gun,' as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow."
It's not entirely clear to me whether "making markets" means on exchanges, or over the counter. The term normally means on an exchange; over the counter, you're a dealer rather than a market maker.
If it's on exchanges, then it has nothing to do with high net worth clients, or any other kind of client, because they won't be trading with their clients specifically, they'll be trading with other market participants.
if it's OTC, then it could be part of a package of services for clients. That would still a bit weird, though, because a bank would normally act as a broker rather than a dealer for its clients - going to the market and finding them the best price, rather than making its own price.
I think that their reason is much simpler: they think they can make money doing it. I guess you could call that FOMO. But basically, they think that with their trading instincts, technology, and famously huge brains, they can move their prices around so that they can buy low and sell high without getting, as we say in the trade, their faces ripped off.
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