Market maker

The defining feature is dealing as principal. A market maker publishes a bid and an ask at the same time and commits to trade at them, so a participant who wants to sell has somebody to sell to and a participant who wants to buy has somebody to buy from, at any moment, without the two of them having to arrive together. What the firm earns for standing there is the bid-ask spread, and what it takes on is inventory: a position it did not choose, in the direction opposite to whoever just dealt.

That inventory is managed rather than held. The firm nets buyers against sellers across its own book, and passes the residual on to a liquidity provider or hedges it in a correlated instrument. On an exchange, designated market makers hold formal obligations in exchange for privileges: a maximum quoted width, a minimum size, and a proportion of the session during which they must quote. In an over the counter market those obligations are contractual or absent, so the term describes a business model there rather than a status.

The structural point follows directly and is often stated as though it were an accusation. A firm that keeps the other side of a position gains when that position loses, which is a counterparty relationship rather than a hidden practice, and regulation requires a licensed firm to identify, manage and disclose it. Practitioners disagree about what follows: one view holds that internalising client flow allows tighter and more consistent quotes than routing every order out, and the other that any firm holding the opposite side has an interest that a purely agency model does not. Both are describing the same arrangement.