Spread Decomposition
From the outside, a spread on an exchange looks like two simple numbers. Bid, ask, done. Underneath, it's a stack of costs plus a read on the competition, and a market maker is constantly nudging it in and out as conditions change. Each component below explains what sets the floor and ceiling, and the scenarios that cause a market maker to tighten or widen.
Adverse selection
The cost of trading against someone who knows more than you. Fill an informed order and the price moves against you; if you consistently get picked off by sharp flow, you get a larger bill than your spread can cover.
Tighten when conditions are stable and information is symmetric — calm tape, no catalyst in sight, and a venue where you understand the order flow. Widen the instant the odds of informed orders rise: around news, listings, liquidation cascades, or whenever your venue lags the price leader and your quotes go stale. This is why a tight spread evaporates the moment volatility spikes — market makers are pricing a higher chance the next fill knows something they don't.
Inventory cost and risk limits
Once filled, you're holding a position you didn't necessarily ask for, carrying directional risk and tying up capital until you hedge or unwind. The spread you see reflects where the market's aggregate inventory already sits. Quote symmetrically when you're flat with capital headroom. Skew your quotes when you're loaded up or near a risk limit — pull in the side that reduces your position, push out the side that adds to it. Every trade you do changes your quotes ever so slightly.
Closely related is the ability to hedge: when market making spot, being able to hedge against a more liquid spot or perpetual contract lets you quote tight because you can get flat instantly. A thin book, bad funding rates, or a constrained venue means you widen, because neutralizing the position is slow and risks more market impact than you want.
Competition and the book
The first two set what you need to charge. Competition sets what the market will let you charge, and most minute-to-minute movement happens inside that band, with your underlying costs unchanged.
Tighten when more market makers are fighting for the same flow, or when you specifically need fill priority for a volume tier or uptime obligation. Widen when competitors pull, when you're the only one quoting a pair, or when a vol spike clears the book and nobody's joining you at the top levels. Often, queue position rather than fair value is what's actually moving your quote.
The takeaway
Think of the spread as multiple independent dials, not one. Adverse selection and volatility widen you on uncertainty, inventory and risk limits widen and skew you when your book is loaded or your exit is thin, and competition decides how much of the volume you actually get to keep. A good quote is always changing — a continuous answer to the question: "Am I getting enough edge for the risk I'm taking on?"
Contact: sales@graniteriver.io