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Crypto markets suffer from a simple but persistent challenge: tokens are only valuable if they can be traded. That sounds obvious, but there’s a lot of work that goes into overcoming this challenge to ensure there is sufficient liquidity for crypto trading to flourish.
This is because the very architecture of digital assets – fragmented across chains, exchanges, and protocols – means that buyers and sellers are rarely aligned at the exact moment a trade is needed. When these opposing forces aren’t matched, the result is slippage and price distortion. People lose money.
Liquidity providers solve this in a variety of creative ways by providing the invisible infra that keeps trading fluid. Speaking of fluidity, the easiest way to picture their role is through an analogy: liquidity providers are like a reservoir feeding a network of pipes. Everyone using the network expects water to flow when they turn the tap. No one asks where the reservoir is, how it’s maintained, or who paid to fill it. They simply expect pressure in the pipes.
Liquidity providers create that pressure. Without them, the tap runs dry.
What a liquidity provider actually does
Liquidity provision means placing assets – usually token pairs – into environments where others can trade against them. On decentralized exchanges, that may be depositing ETH and USDC into a pool so that anyone swapping either asset always has a counterparty. On an order book exchange, it may take the form of setting bids and asks that traders can fill.
The outcome is the same: a smoother trading experience with tighter spreads, lower volatility, and predictable execution.
The importance of a liquidity provider in crypto becomes most obvious when it’s missing. In shallow markets, even modest trades can distort the price. A $10K market buy on a thin altcoin can send the price rocketing; a modest-sized sell can move the chart. Deep liquidity absorbs these shocks, anchoring price discovery to fundamentals rather than random order flow.
The importance of price consistency
It’s easy to measure the first-order effects of deep liquidity: it means that when you go to trade a token, you’re able to swap it at – or very close to – the real-time price quoted on a data dashboard such as CoinCodex or CoinCarp. This is naturally important for you as a trader, but it’s also important for other users, not just on the DEX or CEX where the swap is being executed, but industry-wide.
That’s because the blockchain industry, DeFi especially, is built upon a framework of composability. In other words, financial markets, including liquidity pools, lending platforms, and yield vaults, are powered by smart contracts that draw pricing data from onchain oracles. When liquidity is evenly and plentifully available across the onchain landscape, prices are more consistent. For example, regardless of whether you’re trading USDe on Binance, Uniswap, or Curve, you’ll pay roughly the same price.
This in turn makes it easier for oracles to quote accurate pricing data to DeFi protocols that rely on this information to update their own systems, which also utilize USDe. The more widely an asset is used, and the more ways in which it is used, the greater the need for deep and consistent liquidity. This is the key to keeping onchain money markets operating as expected.
Where market making fits in
We’ve talked about liquidity so far, but what we haven’t discussed is the role played by market makers – specialist firms enlisted to direct liquidity to where it’s needed most. To clarify, liquidity provision is the umbrella concept: supplying assets so that trades can execute smoothly. Market making is a specialization within that category.
Let’s break this down further:
Liquidity Provisioning:
- Supplying assets to the market so trades can occur
- Can be passive (e.g. depositing tokens into a pool)
- Goal: ensure traders can buy or sell without extreme price movement
Market Making:
- Using those assets dynamically to support the order book
- Algorithmically quotes buy and sell prices in real time
- Goal: continuously tighten the bid-ask spread and maintain price efficiency
Put simply, liquidity provisioning ensures there is water in the reservoir. Market making directs how that water flows through the pipes.
As a result, market makers don't merely add liquidity; they manage it. They rebalance positions, optimize spread, maintain inventories, and stabilize price across trading venues. A liquidity provider might passively supply assets into a pool and walk away; a market maker actively sticks around to monitor the trading environment and deploy algorithms to adjust pricing in real-time.
This is an over-simplification of course – a liquidity provider doesn’t literally walk away – but their role tends to be less hands-on than that of a market maker.
Who provides liquidity?
On CEXs, it’s usually dedicated firms with significant capital and custom algorithms who take care of liquidity provision. On DEXs, however, anyone can deposit tokens into a pool. As a result, specialist firms are complemented by retail users – including whales – who are incentivized to supply liquidity and earn a share of the trading fees.
Small LPs add breadth while large LPs add depth, but both entities have an important role to play. Without thousands of smaller LPs, DeFi wouldn’t exist as an open ecosystem. But at the same time, without professional market makers, major tokens would trade like penny stocks, exhibiting high volatility.
Why liquidity providers matter more than ever
The next cycle of crypto growth is being driven not just by speculation but by structural changes. This includes rapid growth in tokenized assets, institutional inflows, RFQ designs, hybrid AMMs, and cross-chain liquidity routing, to name but a few. Crypto is getting more sophisticated, and most of the products and innovations it’s pioneering depend on deep, stable liquidity.
Intent-based execution, where the user specifies the outcome (“best price”) and the backend sources liquidity dynamically, is becoming particularly popular across onchain exchanges, both for spot and perps. This has further heightened demand for specialist liquidity providers to serve as the connective tissue linking venues, chains, and execution layers. Thanks to this trend, liquidity is becoming modular and increasingly automated. In short, liquidity providers are evolving from passive participants into operators of programmable infrastructure.
Liquidity has always been important to crypto. But in today’s fast-paced, multi-asset markets, it matters more than ever. It’s the reservoir that keeps the token taps running.