This page will touch on the difference between DEX and CEX liquidity and the role of a market maker

The Role of Market Makers in Decentralized Exchanges

Despite the unique liquidity management on Decentralized Exchanges (DEXs), the role of market makers remains crucial but differs from that in Centralized Exchanges (CEXs). While CEX liquidity relies on orderbook placements, DEX liquidity, particularly in Automated Market Maker (AMM) platforms like Uniswap and Pancakeswap, is governed by algorithms.

Understanding Liquidity in CEXs

In CEXs, liquidity is generated through limit buy and sell orders placed by users or market makers, which serve as counterparties for transactions. Price formation in CEXs is a result of the agreement between limit buyers and sellers, often influenced by market participants executing orders from the orderbook.

Decentralized Exchanges: Liquidity and Price Formation

DEXs operate on a Peer-to-Contract system, centralizing around liquidity pools created by projects. A standard pool comprises a project token (base token) and a mainstream cryptocurrency like ETH or USDT (quote token). Liquidity in DEXs arises from users depositing both base and quote assets into these pools. The underlying DEX algorithm simulates limit orders by evenly distributing liquidity across various price points, enabling interaction between buyers and sellers.

In DEXs, price is determined by the token ratio in the pool. For instance, if a pool has 50,000 BTC and 1,000 ETH, it indicates a price ratio of 1 BTC to 50 ETH within that pool.

Market Making in DEXs: Balancing and Managing Liquidity

While the DEX algorithm manages liquidity, market makers play a vital role in ensuring price consistency between DEXs and CEXs. They achieve this through strategic buying and selling on DEXs to align prices with those on CEXs.

In liquidity management, particularly with advanced pool versions like V3, market makers can be instrumental in managing liquidity within specific price ranges. The need for professional market making services depends on a project's capital and maturity. For instance, low-volume pools may require minimal management, whereas high-volume pools benefit significantly from expert intervention. Ultimately, the decision to engage a market maker should be based on the project's specific needs and market dynamics.

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