I think this line of reasoning fails to take into account the other argument that I added to the end of my post: that a maker/taker fee model is isomorphic to a change in the user interface. I agree that fixed tick sizes are a good reason why maker/taker models would not be no-ops, but (2) and (3) do not change the basic reality of my argument, which does not make any assumptions about cost structure or competitiveness.
In the maker-taker model, the makers implicitly participate in a price fixing agreement, they agree not to put in a price such that the bid would be equal or larger than the ask. This is because the exchange would otherwise interpret that as a take order with higher fees.
In the interface analogy, this will result in the interface not accepting certain orders that will result in zero or negative spreads.
Suppose a buyer wants to buy at x after fees, and a seller wants to sell x-0.1% after fees.
In a 0.3%-0.3% market this will result in a bid of x-0.3%, and ask of x+0.2%, a 0.5% spread.
In a 0%-0.6% maker-taker market this will result in a bid of x%, and ask of x-0.1%, a -0.1 spread. Negative spreads are not allowed, so given the buy order, the seller is only allowed to sell at higher than x or take a price of x-0.6%.
This price-fixing is profitable for the makers, because they are getting a better price than they would otherwise get.
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- Participants on at least one side of the market pay a fixed cost as well as a cost per unit.
Many retail investors purchase securities from brokers who charges a fixed fee per trade. The broker is legally obligated to purchase the security at whichever exchange offers the best asking price. The legal requirement does not incorporate taker fees charged by the exchange when computing the best asking price. As a result, a disproportionate amount of retail order flow is routed to exchanges that compensate market makers via taker fee rebates rather than through the bid-ask spread.
I think if one searches carefully, it would be possible to identify other types of fixed costs that prevent full pass through. For example, maker rebates are often tiered, so that a maker receives a larger and larger % rebate as he drives more traffic to the exchange. In effect, this is similar to charging makers a tiered membership fee (a type of fixed cost).
Models cannot easily account for all these types of frictions and thus have a tendency to exaggerate pass through.
- The side receiving a subsidy is not perfectly competitive.
This is complicated. I believe that this will boil down to some type of implicit collusion as suggested by the previous poster. I agree that one would need to introduce other factors to explain why competition is relevant. Possible factors include order monitoring costs and information divulged in order updates that would lead to something like an effective min tick size even if the exchange does not enforce one. Competition would tend to increase monitoring and decrease the information content in orders, so that orders are updated more frequently. This would cause the effective min tick size to decrease and lead to greater pass through.
I am not ready to make a rigorous argument though.
The broker is legally obligated to purchase the security at whichever exchange offers the best asking price. The legal requirement does not incorporate taker fees charged by the exchange when computing the best asking price
OK I did not know this. This definitely does seem like the sort of distortion that would cause maker/taker fee models to be attractive.
That said, I would note that all of the reasons given so far that I find credible (minimum tick sizes, legal requirements such as what you give above) seem to be artificial ones created by traditional securities law, and crypto exchanges don’t have these limitations at least at present. So my point about maker/taker models and traditional models being equivalent still stands for crypto exchanges, except possibly for the fact that maker/taker models seem more attractive to makers and reduce apparent spreads so it’s better marketing to display things that way, much like displaying prices with tax not included.
You are assuming that having a minimum tick size or other types distortions is undesirable. This is not true when you have externalities as is the case here. In a two-sided market enforcing collusion on one side of the market generally makes both sides of the market better off. This arises because of cross-side externalities (see the paper I linked to earlier).
My interpretation of your argument would be that crypto exchanges should introduce minimum tick sizes to make liquidity rebate programs more effective. I agree with that.
I am not convinced that liquidity rebates completely wash out in the current system. You need a more complex model that accounts for a range of possible frictions to demonstrate this. Ignoring the prevalence of tiered programs, which do exist on crypto exchanges, is a major oversight.
Think about the decision to be a maker vs. a taker, the maker’s price decision, and the relationship to these decisions to the probability of immediate order execution.
Someone with valuable private information or a retail broker (e.g. Coinbase) charging a large commission will place a high value on certainty of immediate order execution.
The taker’s order executes immediately with probability 1, so If certainty is sufficiently important than you always become a taker.
As a maker, the probability of immediate execution depends on how aggressively you outbid competing offers. If the current bid-ask spread is 0.5% and you make an order that offers a spread of 0.1%, then it highly likely to get taken immediately (though not with probability 1).
The maker taker fee structure limits you to a minimum allowable spread, so that it is not possible to create a maker order that will executes immediately with very high probability.
This forces makers who require near certain execution to become takers and accept a spread of 0.0% instead of say 0.1%.
Thus, the maker-taker fees structure extracts a rent from retail brokers and informed traders and transfers it to market makers.
This won’t work if the exchange market is highly competitive because then the brokers and informed traders would simply migrate to exchanges that do not use make-take fees.
The maker-taker fee structure has nothing to do with narrowing the spread, although that effect is consequential. The spread is not caused by any single market maker, but by a collective, i.e. market maker A may quote bid-ask at 100-105 while market maker B may quote bid-ask at 98-101, thus the NBBO (national best bid offer) is 100-101. The spread is narrowed with increasing participation from any attractive fee structure.
Even then, just because the spread is very narrow does not mean the liquidity in the order book is real. For example, a market maker may be co-located near exchange servers to have first priority in receiving incoming orders from others before such orders are posted. And if the incoming orders are going to impair the market maker, it has the incentive (and ability) to change its bid-ask orders. From outside perspective, the liquidity simply disappears. “Experts” would be quick to say that’s just stale orders.
You may have all sorts of theories on the fee structure to the point of reconstructing it into a perfect structure for the most perfect market condition but you may be surprised when market inefficiencies continue to persist. The fee structure does not have 100% direct correlation to the spread.
I wonder why are we discussing about this anyway. Not useful of time and brain power.