What Is A Liquidity Provider? | Definition for Traders

Liquidity providers, as the backbone of the market, hold large pools of financial assets and supply them as liquidity when needed. Their role is not just crucial but indispensable, as their increased liquidity for brokers leads to lower trading costs, ultimately benefiting the financial market with a positive impact and ensuring its stability.

This article is your comprehensive guide, covering the essentials of liquidity providers, their types, benefits, mechanisms, and importance in your trading journey.

Definition of Liquidity providers

Market Intermediaries: Liquidity providers supply buy and sell orders in a market, ensuring a counterparty is available for traders. They serve as intermediaries, bridging the gap between buyers and sellers while facilitating the interaction between the exchange of commodities and securities.

Incentives: Liquidity providers are driven by a wide array of incentives to provide liquidity to the market. One major incentive is the bid-ask spread, which allows these providers to earn money from the difference between the sell and buy prices they quote. They may also receive commissions for executing these trades and rebates from exchanges or platforms. 

Risk-prone: Liquidity providers face many risks, including inventory, market, and settlement risks. While market risks can arise from fluctuations in asset prices, settlement risks can result from a failure of counterparts to meet their obligations. 

Regulation: This is a key aspect of the financial industry, and liquidity providers are no exception. They are subject to various regulations that ensure investors are protected, and the market is stable. These regulations, including capital adequacy requirements, direct all liquidity providers to a minimum capital level that can cover potential losses, ensuring fair and transparent practices.

Types of Liquidity Providers:

Any type of broker, bank, or hedge fund company can act as a liquidity provider. It does not matter if the broker is an ECN/STP or market broker. Below is the order of how the liquidity providers are arranged:

• Banks
• Prime Brokers
• Prime of the Prime Brokers
• Retail Brokers

The Banks

Banks are at the top of the chain and usually the last to receive any liquidity order. They also share funds with other banks to meet short-term liquidity needs. In times of crisis, central banks offer emergency loans to commercial banks facing liquidity shortages, serving as a lender of last resort.

The Prime Brokers

Prime Brokers provide their liquidity to the retail brokers and prime brokers, which, in turn, pass it on to the banks. Prime brokers also execute trades, ensuring clients can sell or buy securities as efficiently as possible. 

The Prime of the Prime Brokers

Prime of the Prime Brokers obtain their liquidity from the prime brokers and then passes it on to the retail broker. They are also liquidity providers because they provide access to a wide range of FX commodities and securities, ensuring that their clients can access liquidity across various markets.

The Retail Brokers

While Retail Brokers can provide liquidity, they rarely do. However, when they do, they can aggregate the liquidity from various sources, including banks, prime brokers, or prime of prime brokers, to provide their clients with the best price possible.

Can A Broker Be A Liquidity Provider?

Yes, a broker can also act as a liquidity provider. When this happens, they execute the trades on their client’s behalf and provide liquidity for the market. This means that they quote buy and sell prices for assets, security, and commodities for traders who are willing to sell or buy at those prices. 

It also means they profit from bid-ask spreads and commissions and facilitate market transactions. Doing this brings a synergy between brokerage and providing liquidity, enabling market depth and ensuring a fair price for all.

Although this can create a conflict of interest, as the broker might prioritize his interest over those of their clients, it can be reduced by ensuring brokers who double as liquidity providers adhere to strict regulations and guidelines.

Should A Broker Have More Than One Liquidity Provider?

At WR Trading, we recommend choosing a broker with multiple liquidity providers. This is very advantageous because the trader can trade more than the maximum volume, which improves the prices a trader can trade with his broker.

When a broker receives a sell and buy price from each liquidity provider, the broker can select the best buy and sell price and generate the best spread. Therefore, more liquidity providers will mean a larger selection of BID and ASK prices, which can save potential customer costs.

This process takes place at all levels of liquidity providers. The process begins with prime brokers, who source the best prices from banks and calculate the optimal spread. Then, the prime of prime brokers aggregate prices from multiple prime brokers to recalculate an even tighter spread. Finally, retail brokers ideally repeat this process, further refining the pricing to achieve the most competitive spreads for their clients. 

The retail broker then adds his fee to the generated price to cover his services and operations. In essence, the price of the broker’s purchase and what the broker adds in fees is what is called the spread for the end customer.

Functionality in Illiquid Markets 

In illiquid markets, liquidity providers like banks play a crucial role by supplying buy and sell orders, which facilitate trading. They also double as market makers, quoting prices for assets that may have a limited number of buyers and sellers. Market makers are entities that provide liquidity by quoting both sell and buy prices for a financial instrument, thereby creating a market for participants to exit and enter trades, reducing the risk of large price movement.

Although liquidity providers might earn a profit from the spreads, they also play a crucial role in reducing the risk of large price movements. They assume the risk from the market and as such, reduce the operational costs for the customer.

Examples of Liquidity Providers 

Here are examples of some of the best liquidity providers:

• B2B Brokers 
• FXCM Prime 
• Finalto
• Advanced Markets 
• Top FX

B2B Brokers 

B2B Brokers is the best overall liquidity provider, and for good reason. They are a leading liquidity provider for crypto and forex companies. They also cater to different clientele, such as major brokers, crypto exchanges, hedge funds, and professional managers. 

They have unmatched support and integration capabilities as they easily cover marginal accounts, CFD brokers, and spot exchanges. Whether you’re an established player or just starting, B2B Brokers have the features and expertise to help you succeed.

FXCM Prime 

FXCM Prime is a good option for customers needing centralized Forex market information access. With FXCM Prime, traders can enjoy affordable connectivity options, competitive FX liquidity offerings, and market data services.

Additionally, FXCM Prime’s back office expertly aggregates trades from various ECN and bank trading sites, which ensures a cohesive outlook on client positions.

Finalto 

Finalto ensures that people can access global markets through their liquidity, risk, and technology solutions expertise. They offer brokers award-winning multi-asset liquidity from tier-one banks, providing a flexible and responsible high-risk trade execution for their customers.

Advanced Markets 

Advanced Markets Group (AMG) is a leading Prime of Prime solutions provider, regulated by the FCA and ASIC, that empowers top institutional FX brokers with unparalleled multi-bank liquidity and state-of-the-art technology infrastructure. Backed by esteemed institutions like UBS AG and Standard Chartered, AMG has 10+ years of expertise and adheres to the FX Global Code of Conduct. 

AMG ensures that every client order is seamlessly routed to the best-priced Liquidity Provider with a full STP and transparent business model, and this eliminates market risk.

Top FX

Top FX is a Prime CFD Broker with a 12-year track record and provides unparalleled liquidity services to over 180 startups. Their Prime services enable clients to trade over 600 assets, including Forex, Indices, Metal, Shares, Crypto, and other CFDs. Top FX offers negative balance protection, multiple deposit methods, and no deposit fees.

Liquidity Providers in Different Markets:

Here are some of the liquidity providers in different markets:

• Banks
• Financial Institutions
• Trading Firms 

Banks 

Banks provide liquidity to a wide array of financial markets. Banks with large balance sheets can accommodate sizeable transactions, which enables them to make markets for various financial assets. Many of the world’s largest banks are major liquidity providers in many foreign exchange markets.

Financial Institutions

Aside from banks, other types of financial institutions play key roles in shoring up the liquidity of various asset classes. For example, security firms serve as liquidity providers for the New York Stock Exchange.

Trading Firms 

Large trading firms serve as liquidity providers across the capital markets, including those for fixed-income securities, equities, and derivatives. When a retail investor buys a security from a trading firm, the firm fills the order using its inventory, allowing the investor to benefit from their bid-ask spread.

Conclusion 

Liquidity providers are the market participants whose role is to supply liquidity regardless of market conditions and the type of instruments required for trading. Thus helping keep markets liquid in times of economic crises and high volatility.

While several things, such as the styles traders used to trade and earn money, have evolved, some things have remained unchanged, and liquidity providers are one of them. Understanding their roles in the financial markets is important, and you can look through our guide to pick liquidity providers that are suitable to your needs.

Frequently Asked Questions on Liquidity Providers: