Market makers are not the puppet masters people imagine. They provide two-sided quotes and get picked off by informed traders who know more than they do. Here is how adverse selection works, with a concrete example.
No, Market Makers Are Not Moving the Market
Someone mentions market makers in a crypto thread. Within three replies, someone else will say they are manipulating the price. They are the puppet masters. They move markets at will.
None of this is true.
Market makers do not move markets. They get moved by the market. In fact, they are almost always the ones getting picked off — not the ones doing the picking. Here is why.
What a market maker actually does
A market maker stands in the market and posts two prices all day. A bid — the price they will buy at. An ask — the price they will sell at.
If a stock is trading around $100, the market maker quotes:
- Bid: $99.98
- Ask: $100.02
The gap between the two is the spread. In this case, 4 cents.
The business model is dead simple. Buy at $99.98. Sell at $100.02. Pocket 4 cents. Do this thousands of times a day across hundreds of instruments. The spread math does the rest.
The market maker is not placing a bet on direction. They do not care whether the stock goes to $110 or $90. They just want to buy at the bid and sell at the ask, round-trip after round-trip.
The problem: the counterparty chooses when to trade
Here is where it gets dangerous.
The market maker posts both prices and waits. Anyone can walk up and trade against either side. The market maker does not choose who trades with them. The counterparty does.
Most of the time, the counterparty is an uninformed trader. A retail investor buying because they like the stock. A pension fund rebalancing. Someone who just wants exposure. These trades are fine. The market maker earns the spread.
But sometimes, the counterparty is not uninformed.
The concrete example: when informed traders show up
A stock is trading at $100. The market maker quotes $99.98 bid, $100.02 ask, same as always.
A guy walks up and sells 10,000 shares at the bid. He sells to the market maker at $99.98 per share.
The market maker now owns 10,000 shares at an average cost of $99.98. That is fine. They will resell them on the ask side and earn the spread.
Five minutes later, an announcement drops. The company reported earnings that were 40% below expectations.
The stock is now worth $80.
That guy who sold 10,000 shares at $99.98? He knew. He had the earnings data before it hit the public wire. His algorithm processed the text 200 milliseconds faster than the market maker’s feed. He saw “fair value = $80” while the market maker’s quote still said $99.98.
So he sold. Every share he offloaded at $99.98 was worth $80. He pocketed the $19.98 difference per share, times 10,000 shares. That is a $199,800 profit.
The market maker just lost $199,800 on a single trade.
This is adverse selection
The informed trader self-selected as the counterparty. He traded only because the market maker’s quote was stale. He would not have traded at $80. He traded because the quote was wrong.
The uninformed trader trades no matter what. The informed trader trades only when the market maker is wrong. The market maker cannot tell them apart in the moment.
Every trade with an informed counterparty is negative expected value for the market maker. The small spread they earn from uninformed flow has to cross-subsidize the big losses from informed flow.
This is not a bug. It is the central risk of the business. The academic name is adverse selection. Bagehot formalized it in 1971. It is the reason market makers exist — and the reason they sometimes go under.
So who moves the market?
Informed traders move the market. Their trades reveal information. When someone with better data starts selling, the price falls. Not because market makers are manipulating anything. Because orders that carry information get filled, and the market reprices around that information.
The market maker is a price taker, not a price maker. They quote based on what they see in the order book and what they know about the current state of the world. When that information lags reality, they get picked off.
HFT is a technology, not a strategy
This is where people get confused.
HFT stands for high-frequency trading. It means you use fast computers, colocated servers, and low-latency network connections. It describes how you trade, not what you trade or why.
An HFT firm can do many things with that technology. Stat arb, event trading, latency arbitrage. But the single largest use case is market making. Jane Street, Optiver, IMC, Citadel Securities, Tower Research, Graviton — all of them are primarily market makers. Their core business is posting two-sided quotes and earning the spread.
When Jane Street quotes a price in Indian single-stock options or on NSE equity derivatives, they are not placing a directional bet on Reliance. They are running the same business model as the hypothetical market maker above — posting bids and offers, earning fractions of paise per share, and losing money whenever someone faster processes the RBI announcement before they do.
The speed is defensive. It lets them cancel and reprice their quotes before informed traders can pick them off. It does not give them an informational edge over the market. It gives them a survival tool.
Why the spread exists
The spread is not greed. It is insurance.
If a market maker sets the spread too tight, their profit per uninformed trade is tiny. One adverse trade wipes out hundreds of good trades. They go out of business.
If they set the spread too wide, nobody trades with them. A competitor with a tighter spread takes the flow.
The equilibrium spread is the price of providing liquidity in a world where some counterparties know more than you do. Wider spreads in volatile, opaque, or news-sensitive names are not predatory. They are survival math.
In crypto specifically, spreads are wider than in traditional markets. Not because crypto market makers are greedy. Because information asymmetry is higher. On-chain activity, exchange listings, regulatory announcements — the information moves faster and reaches fewer people. The risk of being picked off is higher. The spread compensates for that risk.
The bottom line
Market makers are not the villains. They are liquidity providers who stand in the market, post two-sided quotes, and absorb the risk of being traded against by people who know more than they do.
Informed traders are the ones who move prices. Their orders carry information. The market reprices around them. Market makers are on the other side of those orders, losing money, more often than anyone wants to admit.
The next time someone in a crypto thread blames market makers for manipulating the price, ask them: who actually knew something first?