A liquidity provider (LP) is integral for on-demand access to liquidity for tradable financial markets. They unite funds and financial institutions to form a pool of liquidity available to market participants. Common purposes include:
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general access to funds,
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creating favourable trading conditions,
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reducing the spread,
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large order stabilisation,
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strategy implementation and
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improving volume and high frequency trading activity.
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LPs are often market makers, providing liquidity by constantly buying and selling to reduce the bid-ask spread. Similarly, a broker provides access to the liquidity, acting as an intermediary between buyers and sellers via a trading platform.
Brokerages typically partner with several liquidity providers, ensuring adequate liquidity and pricing for traders. Brokers can also be market makers if the transaction is not transferred to the liquidity provider.
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Tier 1 liquidity providers: the largest, include international banks and hedge funds that can facilitate significant liquidity.
Tier 2 liquidity providers: smaller, typically act as a conduit between a smaller broker and a Tier 1 liquidity provider.
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Types of liquidity providers include aggregators, banks, brokers, crypto exchanges, ECN, non-banks, prime brokers, prime of prime, MCP networks and retail brokers.
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