What are liquidity providers?

A liquidity provider (often abbreviated to 'LP') is an entity which provides access to liquidity for another entity in order to achieve a specific financial purpose. In simple terms, a liquidity provider offers access to tradable instruments for another company to trade.

This could either be by providing access to funds, or implementing a strategy of buying and selling securities to create more favourable conditions for brokers or exchanges.

A liquidity provider is a loose term, and can often be synonymous with market maker and also a broker – however, there are some key differences to be aware of.

By providing access to liquidity, liquidity providers can ensure markets run smoothly, as there is enough volume available for trades to occur with fewer delays and a more stable price. 

For a more detailed explanation on what liquidity is, check out our simple guide on the definition of liquidity. 

In this article, we go into detail about exactly what a liquidity provider is, what they do, and whether you might need one for your business.

What does a liquidity provider do?

A liquidity provider provides cash or assets to a financial institution, or sources liquidity on its behalf. There are multiple ways in which institutions may require liquidity.

Often forex brokers and institutions will require liquidity providers, as the forex market requires a large amount of liquidity to facilitate the high frequency of trades. However, many businesses of all sizes will require liquidity.

Here are two of the main roles of which a liquidity provider will take:

Market makers

A market maker is one of the most common forms of liquidity provider and plays a crucial role in the financial markets. The function of a market maker is to either continuously buy and sell a particular asset or security, thus providing stability in a particular market, as it ensures there is always someone to trade with, or provide enough liquidity to ensure a trade can always be made.

By using liquidity in this way, it means that the bid-ask spread becomes significantly smaller, and buyers and sellers can be assured of their trade going through. Without a market maker, if a stock or currency pair is moving, it may be difficult to buy or sell – a market maker solves this issue.

Brokers

A broker is an individual or an institution which helps someone buy or sell an asset, such as a stock or currency. A broker connects buyers and sellers, but doesn’t purchase the assets themselves, often serving as an intermediary between retail traders and the wider financial market. In this way, a broker provides access to liquidity, but does not produce the liquidity.

Different sizes of liquidity providers

Liquidity providers can be vastly different in size. Some might be small-time brokers, others might be global financial organisations keeping control of the markets. 

The sizes are split into two categories: Tier 1 and Tier 2.

Tier 1 liquidity providers

Tier 1 liquidity providers are the largest. These will include large international banks and hedge funds that can provide a huge amount of liquidity, normally in the forex industry.

Examples of Tier 1 liquidity providers include banks such as Deutsche Bank, Morgan Stanley and Barclays – global leaders in providing liquidity for the forex industry.

Tier 2 liquidity providers

Tier 2 liquidity providers are smaller, and can act as a bridge between a smaller broker and a Tier 1 liquidity provider. Tier 2 liquidity providers are a lot more common and more accessible for many businesses.

Types of liquidity providers

In terms of service, there are a variety of liquidity providers, all providing a particular service for where liquidity is needed.

These include, but are not exclusive to:

• Aggregators 
• Bank providers 
• Broker providers 
• Digital providers 
• Crypto exchanges 
• ECN providers 
• Non-bank providers 
• Bank providers 
• Prime broker providers 
• Prime of prime providers 
• MPC network providers

Many of these providers fit into the categories of market makers or brokers, but offer specific services within them. For example, an Electronic Communication Network (ECN) provider uses computer-backed systems to automatically match buy and sell orders for securities in the market, which is used to increase liquidity. In this way, ECN providers act as market makers.

Is a liquidity provider the same as a broker?

No, although they are very similar and can be used interchangeably – a broker can be a form of liquidity provider.

A broker is an individual or institution who buys and sells securities or financial products on behalf of investors, which are often banks or funds. 

A liquidity provider can be a market maker, an investment bank, a high-frequency trading firm, or a financial institution, and also a broker.

Liquidity providers focus on maintaining market liquidity, and keeping the bid-ask spread consistent, whereas a broker will act as an intermediary to connect traders with liquidity providers.

Is a liquidity provider a market maker?

Liquidity providers are often referred to as market makers. This is because often liquidity providers will fulfil this role, but liquidity providers can be any institution that provides access to liquidity.

In short, market makers are liquidity providers, but not all liquidity providers are market makers.

What are liquidity providers in crypto?

Liquidity providers in cryptocurrency markets operate the same way as the regular financial markets. They supply buy and sell orders to increase market liquidity.

As the crypto market is more nascent, and often certain cryptocurrencies are only used by a small pool of people, liquidity providers play an essential role in establishing new cryptocurrency assets.

Choosing a liquidity provider

Finding a liquidity provider for your business can be a tricky process. 

At LiquidityFinder, we aim to make that process simple, and provide you with a network of liquidity providers and other financial institutions.

Looking for a liquidity provider? You can see our list of current providers here. (TIP: You can search the list of LPs from this page by Asset Class)

To help our users find the right liquidity provider, we have our Match Matrix tool, which works by taking in your details, and connecting you with the best-suited liquidity provider in our network.

We also have our multi-provider request form, which will help you find partners more easily.

Author

Caleb is a financial copywriter with a specialisation in fintech and forex. Former copywriter at Barclays and Paysafe. Contributing writer for LiquidityFinder.