Liquidity Providers Explained: Their Role in Financial Markets

Samer Helbaoui

Article by: Samer Helbaoui, Vice President – Gulf Regional Growth, ViewTrade

Liquidity is a crucial part of any market. It is the concept of ensuring there is sufficient access to a product or asset, allowing a market to operate efficiently. Without liquidity there is no efficient market. In financial markets, liquidity refers to the ease with which assets can be bought and sold. This drives how efficiently our financial markets operate, providing access to buyers and sellers and creating a mechanism to control unnecessary price fluctuation.  

It keeps the market flexible, stable and ready to meet the financial requirements of the investors. Liquidity providers can be broken down into the type of firm providing liquidity and the activities or concepts a firm uses to create liquidity.

Examples of the types of firms:

• Investment banks
• Specialized market making firms (high frequency traders)
• Hedge Funds
• Broker dealers
• Custodian Banks

Examples of the concepts or activities undertaken:

• Market Making – Continuously quoting bid and ask pricing. Holds inventory
• Underwriting and Distribution – Issuing new stocks (IPO’s)
• Algo trading – Exploiting price discrepancies across exchanges and markets
• Internalization – Financial Services firms filling orders from their own inventory 

This article aims to give you a glimpse into how liquidity providers ensure market efficiency and stability, why they are significant to the system and how their presence impacts the market’s effectiveness.

What is a Liquidity Provider (LP)?

Liquidity providers are entities that ensure there is enough assets available to create an efficient market. They do this by quoting the buy and sell prices of assets, creating market depth and ensuring a constant supply of securitized assets in the market. This mechanism ensures that assets can be bought or sold significant pricing fluctuations. They quote the buy and sell prices of assets in a market, ensuring that there are sufficient pools of assets to accommodate buyers and sellers, thus ensuring consistent and efficient trading.

Their function includes:

1. Buying securities and holding inventory
2. Selling to institutional buyers and retail investors.
3. Keeping the buy-and-sell cycle active to ensure market sustainability.

Liquidity providers ensure that there is no scarcity of securities even when the number of buyers in the market is less. Without them, trading would be a tedious process, slowing down the market in turn and attracting only a niche segment of investors.

Types of liquidity providers

Although they all provide liquidity, LPs are categorized into various types because of the different ways in which they function. Based on their function, liquidity providers are classified into four major categories – Tier 1 liquidity providers, market makers, broker-dealers, institutional investors and other liquidity providers.

Tier 1 Providers

Tier-1 providers include major banks and financial institutions – Barclays, Deutsche Bank Morgan Stanley, and Goldman Sachs to name a few, which are all major players in the market. They have the largest market capitalization and are technologically equipped to provide institutional clients access to a large pool of liquidity in various different markets, and asset classes.

Market Makers

Market makers continuously quote buy and sell prices and ensure liquidity is available for both buyers and sellers. They also actively manage their positions to profit from the spread between the bid and ask prices. By this mechanism, the bid-ask spread remains modest, reducing price volatility and allowing investors easy access to the market.

Brokers & Intermediaries

Brokers and intermediaries help investors manage their portfolios and find the right assets to buy or sell. They contribute to liquidity by enabling investors of all scales to access assets, thus contributing to an even buy-sell cycle. Their role helps to reduce trading friction, narrowing bid-ask spreads, and keeping the markets active and accessible.

High-Frequency Trading Firms (HFTs)

HFTs use advanced algorithms and automation to execute large volumes of trades at extremely high speeds. They take advantage of small price differences while providing liquidity in the market.

 Algo trading

Exploiting price discrepancies across exchanges and markets. This helps correct potential mispricing and, in effect, tightens the bid-ask spread.

Internalization

Broker-dealers (BDs) filling orders from their own inventory.

Others

Smaller entities that contribute to the market’s liquidity include aggregators, crypto exchanges, digital providers, etc.

The Role of Liquidity Providers in Financial Markets

Liquidity providers help ensure that there are sufficient pools of assets to facilitate the trading needs of all investor types. The effect, and benefit to investors, is that the bid ask spread is effectively managed via this process, mitigating unnecessary price fluctuations. Here is a blueprint of how these entities contribute to making the trading process efficient.

Stabilizing Order Placements

Large-scale investors often place bulk orders, which can create a temporary dearth of certain assets and drive up their prices. Liquidity providers, including market makers, help stabilize the market by consistently placing buy and sell orders. This process balances the volume of trades, allowing other investors to continue trading without major disruptions.

Reducing Bid-Ask Spreads

By providing the mechanism that facilitates the continuous flow of the buy and sell orders, liquidity providers help reduce the buy and sell price difference and prevent the market from swinging to extremes. This reduces the bid-ask spreads, leading to a more stable and investor-friendly ecosystem.

Underwriting IPOs

Some of the major liquidity providers (typically banks, broker dealers and other major liquidity providers), buy Initial Public Offerings directly from companies that wish to go public and sell them to retail investors and institutions.

What are Some of The Challenges Faced by Liquidity Providers?

Keeping Up with Advanced Finance Technology

With AI and automation being at the core of many financial institutions’ trading strategies, traditional providers like banks and other Tier-1 providers face the threat of technological stagnation compared to newer more technology driven businesses.

Non-bank LPs’ revenues increased by 22% from 2023 to 2024, reaching $25.6 billion. This growth is outpacing that of traditional investment banks. While traditional banks still hold a larger share of the market, the growth of non-bank liquidity providers (NBLPs) is significant.

Source: Coalition Greenwich, May 2025 – https://www.greenwich.com/free-tags/non-bank-liquidity-providers

With the rampant use of AI, new liquidity providers have developed high-speed algorithms that can process buy and sell orders faster than many traditional players in the market. Technological advancements around AI and Machine Learning will continue to drive innovative strategies in areas like predictive analytics, adaptive algorithms, hyper-personalization and risk management.

Monitoring And Capturing Liquidity Fraud

With the rapid pace of AI and modern technology, the risk of increased cases of spoofing and cyber-attacks cannot be avoided. Organizations must ensure that the necessary pre-trade monitoring software is employed and delegated to keep online trading malpractices in check, to avert any major crises in the future. This is where ViewTrade’s clients stand to gain. Our proprietary Order Management System (OMS) and risk management technology allows for both pre- and real-time trade monitoring, allowing our customers complete control over their trading activity.

Implementing Regulations to Ensure Compliance

Changing financial technologies call for the latest regulations to be implemented. While expanding technology, organizations must also consider the ever-evolving regulatory requirements.

The Way Ahead for Liquidity Providers

Without liquidity providers, markets would be less efficient, more volatile, and subject to wider spreads and higher transaction costs. Their participation in the market ensures that buyers and sellers can transact at any time, fostering confidence and encouraging broader market participation.

In summary, liquidity providers are an essential component of the financial markets. By ensuring assets are always available for trade, they promote stability, efficiency, and resilience – qualities that benefit all market participants, from individual investors to large institutions.

FAQs

What is a liquidity provider in financial markets?

A liquidity provider ensures that there are enough assets (liquidity) available to maintain an efficient mechanism for buyers and sellers to execute their trades without significant price movement.

The real-world impact of this broad network of liquidity providers (LPs) is that buyers and sellers can now buy or sell assets easily, often even beyond normal market operating hours.

Who are examples of liquidity providers?

Investment banks, specialized market making firms (high frequency traders), hedge funds, custodian banks and broker-dealers.

How does ViewTrade support liquidity?

ViewTrade provides its services to customers by acting as an aggregator of various liquidity providers. ViewTrade is intensely focused on managing and mitigating risk and does not make markets or trade our own inventory. Instead, we manage our clients’ order flow by utilizing a panel of liquidity providers to ensure our customers receive a highly efficient order execution experience.