How Does the Concept of “Payment for Order Flow” (PFOF) Relate to Market Maker Incentives?

PFOF is a practice where a broker receives compensation from a market maker for routing customer orders to them for execution. This incentivizes the market maker by guaranteeing them a steady stream of order flow, which they can profit from via the bid-offer spread.

While controversial, PFOF effectively lowers the market maker's cost of acquiring orders, which can lead them to offer slightly tighter spreads to the broker's customers.