How Do Market Makers Work?
TL;DR: How Market Makers Control the Flow
- Market makers provide instant liquidity by quoting buy and sell prices simultaneously for the same asset.
- Revenue is primarily generated through the bid-ask spread rather than directional price movement.
- High-frequency trading (HFT) accounts for 70% to 80% of total U.S. equity trading volume in 2026.
- Electronic firms like Citadel Securities and Virtu Financial now dominate traditional banks in market share.
- In 2025, off-exchange trading volume surpassed 50% for the first time in financial history.
- Modern market makers use Agentic AI to manage 24/7 liquidity across crypto and prediction markets.
Updated: March 2026
Market makers are the invisible architects of every transaction you execute. Without them, you would wait hours or days for a counterparty to match your specific trade price. These institutions ensure that liquidity remains constant even during periods of extreme market volatility.
The Fundamental Role of a Market Maker
A market maker is a firm or individual that stands ready to buy and sell securities at all times. They act as the primary middlemen in financial markets. Their presence allows retail traders to enter and exit positions instantly.
They provide two prices for every asset: the bid and the ask. The bid is the price they pay to buy from you. The ask is the price they charge to sell to you. This dual-sided quoting system creates the continuous market environment we see on platforms like Kalshi and Polymarket.
Market makers do not typically look for long-term investments. They aim to remain delta neutral. This means they balance their inventory so that price swings do not affect their overall capital. They profit from the volume of trades rather than the direction of the market.
How Market Makers Generate Revenue
The primary source of income for a market maker is the bid-ask spread. This is the difference between the buying price and the selling price. While the spread on a single share may be a fraction of a penny, it adds up over millions of trades.
According to a 2025 report by Coalition Greenwich, the mantra for modern firms is being smarter and fast enough. Speed is no longer the only factor. Firms now use AI for prediction market trading to optimize these spreads in real-time. This ensures they capture the maximum spread while minimizing their own risk.
Payment for Order Flow (PFOF) is another major revenue stream. Retail brokerages like Robinhood send their customer orders to market makers. In exchange, the market makers pay the broker a small fee per share. This practice allows for zero-commission trading but remains a point of regulatory debate.
The Shift to Electronic Market Making
Traditional big banks have lost significant ground to electronic firms. Names like Citadel Securities, Virtu Financial, and Susquehanna now lead the industry. These firms leverage agile, cloud-based technology rather than legacy banking systems.
In 2025, off-exchange trading volume officially surpassed 50% of total market share. This includes dark pools and internalizers. Phil Mackintosh, Nasdaq Chief Economist, stated in early 2026 that the market is the darkest in the middle of the day. This refers to the high volume of trades happening away from public exchanges.
This shift has made price discovery more complex. Electronic market makers use proprietary algorithms to find the best prices across multiple venues. They provide the backbone for legal prediction markets and traditional stock exchanges alike.
The V.I.S.A. Framework for Market Liquidity
To understand how market makers evaluate any given contract, we use the V.I.S.A. Framework. This helps traders identify when a market maker is providing a fair price or when they are widening spreads due to risk.
- Volume: High volume allows market makers to tighten spreads because they can exit positions quickly.
- Inventory: If a market maker holds too much of one side, they will shift the price to encourage the opposite trade.
- Sentiment: Market makers track social and news data to anticipate sudden spikes in volatility.
- Asymmetry: They watch for "informed flow" or smart money detection to avoid being on the wrong side of a professional trade.
Market Making in Prediction Markets
Prediction markets like Polymarket and Kalshi rely heavily on specialized liquidity providers. These firms quote prices on everything from election results to economic data. They ensure that binary contracts always have a tradable price.
Following the 2024 U.S. election, volume on these platforms surpassed $1 billion per week. This growth attracted institutional market makers who previously only traded equities. They use native API data feeds to manage thousands of event contracts simultaneously.
Market makers in this space must be experts at understanding implied probability. If a contract is mispriced compared to real-world data, they risk being "picked off" by informed traders. This makes the role of a market maker in event trading much more research-intensive than in standard stocks.
The Impact of HFT and AI
Automated high-frequency trading (HFT) systems now account for 70% to 80% of total trading volume in U.S. equity markets. These systems react to news and price changes in microseconds. They provide the deep liquidity that allows for low minimum trade sizes on modern platforms.
The AI trading platform market is projected to grow to nearly $70 billion by 2034 (Amra and Elma, 2025). This growth is driven by the integration of Agentic AI. These agents can make autonomous decisions about liquidity provision without human intervention.
Sanjay Wadhwa, SEC Enforcement official, recently warned that some crypto firms use these tools for wash trading. This creates artificial volume to deceive investors. It is crucial to use tools like PillarLab to distinguish between real professional flow and manipulative bot activity.
Inventory Management and Risk
A market maker's biggest fear is "toxic flow." This happens when they trade with someone who has better information than they do. To protect themselves, they constantly adjust their quotes based on their current inventory.
If a market maker has bought too many "YES" contracts on a specific event, they will lower the price they are willing to pay for more. Simultaneously, they will lower the price they are selling at to attract "NO" buyers. This balancing act is essential for maintaining a neutral position.
Traders can monitor these shifts by tracking volume changes in real-time. When a market maker's inventory becomes unbalanced, it often creates a temporary gap. Savvy traders use Polymarket analysis tools to find these entry points.
Regulatory Challenges and PFOF
Payment for Order Flow remains one of the most controversial topics in finance. Critics argue it creates a conflict of interest. They believe brokers might not provide the best execution for their clients if they are being paid by a market maker.
However, proponents argue that PFOF is the reason retail traders enjoy commission-free trading. Without these payments, the cost of entering a position would rise significantly. Regulators in the UK and EU are currently reviewing these structures as they transition to T+1 settlement cycles.
In the United States, the CFTC and SEC continue to monitor how these incentives affect prediction market accuracy. The goal is to ensure that market makers are providing genuine liquidity rather than just extracting fees from retail participants.
Liquidity Depth and Slippage
Liquidity depth refers to the volume of orders available at different price levels. A deep market allows for large trades without significantly moving the price. Market makers are the primary providers of this depth.
When liquidity is thin, traders experience "slippage." This is the difference between the expected price of a trade and the actual price at which it executes. Understanding how liquidity affects odds is vital for anyone trading large positions.
"The integration of Agentic AI is becoming the primary differentiator for generating alpha in 2026," states a recent Coalition Greenwich Report.
Market makers use these AI tools to provide depth even in niche markets. This has led to the rise of attention markets on Polymarket, where liquidity can appear and disappear in minutes based on viral trends.
Market Makers vs. Market Manipulators
It is important to distinguish between legitimate liquidity provision and market manipulation. A market maker provides a service by facilitating trades. A manipulator uses wash trading to create a false sense of activity.
In October 2024, the SEC charged several firms for providing "market-manipulation-as-a-service" in the crypto space. These firms used bots to inflate volume and lure in retail investors. This is why detecting market manipulation is a core focus for PillarLab's analytical pillars.
Legitimate market makers are usually regulated entities. On platforms like Kalshi, they must follow strict rules regarding fair pricing. You can learn more about these protections by checking is Kalshi legal in the US for your specific state.
The Future of Automated Liquidity
The future of market making lies in total automation. We are moving toward a world where 24/7 markets are the norm. This requires market makers to operate without human sleep cycles or breaks.
The transition to T+1 settlement in North America has already forced firms to automate post-trade processing. As the UK and EU follow suit in 2025 and 2026, the global financial system will become even more integrated. This increases the speed at which odds update across different platforms.
For the average trader, this means tighter spreads and better execution. However, it also means the "analytical advantage" is harder to find. Using a professional prediction market software like PillarLab is becoming a requirement to stay competitive against these high-tech firms.
How to Trade Alongside Market Makers
You should never try to "beat" a market maker at their own game. They have more data and faster execution than any individual. Instead, you should look for the gaps they leave behind when they are managing their risk.
When a major news event occurs, market makers often widen their spreads to protect themselves from volatility. This is often the best time to trade event markets if you have a high-conviction view. You are essentially providing the liquidity the market maker is temporarily unwilling to offer.
By reading Polymarket order flow, you can see where the market maker is "stacking" their orders. If you see a large block of sell orders at a certain price, that is a clear signal of where the market maker is trying to reduce their inventory.
FAQs
What is the difference between a market maker and a broker?
A broker acts as an agent that finds a trade for you. A market maker acts as the principal that takes the other side of your trade directly from their own inventory.
Do market makers lose money?
Yes, market makers can lose money if the market moves too fast for them to adjust their prices. They also lose money if they trade against "informed" participants who have better data.
Is market making legal in all markets?
Market making is a legal and regulated activity in traditional finance and on platforms like Kalshi. In unregulated crypto markets, the line between market making and wash trading is often blurred.
How do market makers handle 24/7 trading?
They use autonomous AI agents and high-frequency algorithms to manage liquidity and inventory around the clock. This allows them to provide continuous quotes without human intervention.
Can I become a market maker?
While individuals can provide liquidity by placing limit orders, professional market making requires significant capital and high-speed infrastructure. Most retail traders instead focus on finding expected value in existing markets.
Why are spreads wider in some markets?
Spreads widen when there is low volume or high uncertainty. Market makers increase the spread to compensate for the higher risk of holding an asset they might not be able to sell quickly.
Final Takeaway
Market makers are essential for the health and efficiency of modern trading. They provide the liquidity that allows for instant execution and tight spreads. By understanding their incentives and the V.I.S.A. framework, you can better navigate the complexities of both traditional and prediction markets.