Who Provides Liquidity to the Forex Market？

Source: Fazzaco 2020-08-14

The term “liquidity provider” is used to refer to one that provides liquidity.

A Forex liquidity provider is essentially someone willing to take the two sides of a trade (buy and sell) by readily offering the two Bid and Ask quotes (usually with a spread).

To understand this clearly, let us look at an example:

If you walk into a Forex bureau seeking to exchange your pounds for dollars, you will be readily provided with a price quote to complete the transaction. The Forex bureau takes the exchange rate risk on your behalf and for your convenience making a profit from the spread between their selling and buying prices. The Forex bureau is able to make this transaction since it gets it currencies at a better price (smaller spread) from a larger banking institution.

In this example, the Forex bureau has played as your liquidity provider while the larger bank has played as the Forex bureau’s liquidity provider.

In a word, a Liquidity Provider (LP) in the FX Industry is a company that streams prices through a bridge into a FX Broker’s online trading platform and takes the other side of the FX Brokers client’s trades. While a FX Broker is typically a Business to Consumer (B2C) company, a Liquidity Provider is usually a Business to Business (B2B) company.

Different Types of Forex Liquidity Providers

There are basically two types of liquidity providers in forex: Tier 1 and Tier 2 liquidity providers.

1) Tier 1

The Tier 1 liquidity providers in the foreign exchange market are at the apex of the food chain. This class of liquidity providers is populated by the biggest banks in the world who provide price quotes for all the currency pairs that use ECN (Electronic Communication Network) in the market. Basically, these giant banks set the benchmark for the liquidity making the market for forex brokers and traders.

According to the Bank of International Settlements, about 70% of the liquidity in the foreign exchange market comes from global banking giants such as Citibank, Deutsche Bank, HSBC, JPMorgan Chase, UBS, etc.

Tier 1 Forex Liquidity Providers primarily make money by:

Charging Spread which is the difference between the bid and ask prices for a symbol.
Charging Commission on Trades (Buy – Sell)

2) Tier 2

The Tier 2 liquidity providers, on the other hand, are known as market makers in the forex space. A market maker is basically any company that is ready to sell or buy an asset at a publicly quoted price on a regular and consistent basis. In the forex market, this asset is essentially the currency pairs among other instruments.

These Tier 2 liquidity providers act as intermediaries between the end clients (traders) and the big banks. They enhance the liquidity in the market making sure that there is always a buyer or seller to fulfill trade orders. Small and medium financial institutions, brokerage solution providers or prime brokers, are some good examples of Tier 2 liquidity providers.

Basically, the Tier 2 liquidity providers get liquidity from the Tier 1 providers and offer this pricing with a small mark-up to the end retail clients.

How do market makers make money? They make their money from the spread. By acting as counterparties, they also receive profits from losing trades in the market.

Later, Fazzaco will give a detailing introduction between the liquidity provider and market marker.

(Source: allfxbrokers, liquidity-provider and medium.com)

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Who Provides Liquidity to the Forex Market？

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