Is an encrypted market maker the ‘behind-the-scenes dealer’?

Is an encrypted market maker the hidden dealer?

Author: Day

In the encryption industry, behind the drastic fluctuations of some tokens, there is often the shadow of market makers. As the hidden “market makers” behind the scenes, they are often criticized by the encryption community for “market manipulation”. The recently popular Worldcion was revealed to have signed an agreement with market makers to lend tokens to five market makers to provide liquidity for WLD.

Today, let’s briefly understand the mysterious “market makers”.

What is a market maker

To understand market makers, you need to understand the concept of liquidity. If an asset can be sold in full quickly, we can say that it has good liquidity. Conversely, if an asset can only be sold at a discount or takes a lot of time to sell, it lacks liquidity. It describes the ease, speed, and low cost at which buyers and sellers can trade in the market.

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Just like the pools in DEX, when we buy on different dexes with the same amount of funds, there will be differences in the quantity purchased between UNI and CRV, or differences in the amount of funds obtained when selling the same quantity. This is liquidity. We should understand that the liquidity of a project can directly determine the life or death of the project. If there is no liquidity, the project is essentially dead. The project party rushes to go on certain head platforms (going on certain platforms means good news) because going on these platforms means increased liquidity and more potential users.

The market makers we are going to talk about today play a major role in providing liquidity to the market. Many market manipulations are also based on liquidity.

The concept of market makers originated from the securities market, but it is also applicable to the encryption market. Market makers play multiple important roles in the encryption market and play a key role in the development and operation of the market.

The following are the main roles of market makers in the encryption market:

• Provide liquidity: Market makers provide a highly liquid environment for market participants by constantly providing quotes for both buyers and sellers, promoting fast transactions, reducing costs, and increasing participation;
• Maintain market stability: During market fluctuations, market makers balance the supply and demand relationship by continuously adjusting pricing strategies and executing buy and sell orders, preventing drastic price fluctuations, maintaining market stability, and providing a more reliable environment;
• Promote market development and maturity: Market makers provide liquidity for start-up projects, increase market attractiveness and tradability, attract more investors to participate in the market, and promote market development and maturity;
• Provide advice: As important participants in the market, market makers accumulate rich market data and information, which are of significant reference value to customers and can help them make wiser investment decisions.

There are several main types of clients for market makers:

• Trading platforms: Trading platforms need to provide a highly liquid market environment to attract more investors and funds to enter the platform;
• Investment institutions: Investment institutions usually need to conduct large-scale transactions in the market, so they need sufficient liquidity support. Market makers help investment institutions efficiently execute trading strategies and reduce costs;
• High-frequency trading companies: Market makers provide high-frequency participants with a fast execution and low-latency environment, meeting their needs for high-speed trading;
• Individual investors: Although individual investors have smaller trading volumes in the market, they can also benefit from the services of crypto market makers.

Development of Market Makers

The development of crypto market makers has gone through the following stages:

Early Stage

• When the crypto market just emerged, the lack of liquidity was a major problem. The order book of the platform was often very sparse, with large bid-ask spreads and high costs. At this stage, some individuals or small teams began to provide market-making services to improve the market situation by providing quotes and liquidity, and early arbitrage also falls into this category;

Specialization Stage

• With the development and maturation of the crypto market, more and more specialized market makers have emerged. These market makers are usually composed of professional teams or companies, with more abundant funds, technology, and market experience. They use more advanced algorithms and trading systems to provide higher quality liquidity and tighter bid-ask spreads;

Institutional Participation Stage

• With the increasing interest of institutional investors in the crypto market, more and more traditional financial institutions and institutional investors have started to participate in crypto market-making business. These institutions usually have larger capital scales and more sophisticated risk management capabilities, enabling them to provide larger-scale liquidity support and bring more participants and trading volume to the market.

Innovation and Intensified Competition Stage

• With the intensifying competition in the crypto market, market makers are also constantly innovating and improving. Some market makers are starting to try new trading models and strategies, such as high-frequency trading, arbitrage, etc., to improve efficiency and profitability. At the same time, the continuous advancement of technology provides market makers with more tools and means, such as machine learning, big data, etc., to optimize trading decisions and risk management.

Liquidity Incentives

• By the way, Uniswap, which innovatively proposed AMM, is also a kind of market maker. It allows anyone to participate in market making and receive rewards. DeFi has also rapidly developed and continued to innovate because of this;

Phase of Enhanced Compliance and Regulation

• As the cryptocurrency market develops, regulatory agencies are also increasing their supervision of cryptocurrency transactions.

Overall, cryptocurrency market makers continue to evolve and adapt to meet market demands and provide a more efficient trading environment. They play an important role throughout the entire period of the cryptocurrency market.

Profit Methods of Market Makers

Like traditional market makers, cryptocurrency market makers also profit from the spread between buying and selling prices. However, due to the lack of regulation in the cryptocurrency market and the low cost of misconduct, the flow of information and decision-making power is mainly controlled by industry leaders. Market makers in the cryptocurrency industry are easily associated with market manipulation, and individual investors are vulnerable to being taken advantage of.

1) The main sources of profit for market makers are as follows:

• Spread: Market makers profit by offering simultaneous buying and selling prices in the market, taking advantage of the spread between them. They set lower buying prices and higher selling prices, earning profits from the price difference. This difference is commonly known as the “spread” and is one of the main sources of profit for market makers;
• Trading fees: While providing liquidity, market makers also charge fees according to the platform’s regulations. These fees are paid by participants to the platform, and market makers, as liquidity providers, can earn a portion of them as profit;
• Arbitrage trading: Market makers usually take advantage of price differences between different platforms or market fluctuations to conduct arbitrage and earn profits. This type of arbitrage operation often requires fast execution speed and highly automated trading systems;
• Liquidity incentives: Some platforms or protocols provide incentives to market makers who provide liquidity, such as token rewards.

It can be seen that market makers’ revenue mainly comes from two sources:

A. Serving project teams

B. Serving trading platforms

2) The relationship between market makers and project teams

The relationship between project teams and market makers is mainly established through the provision of liquidity services, especially when new projects are launched and market makers are needed for price management. Market makers play three main roles:

A. Providing liquidity

B. Stabilizing prices to prevent project failure due to excessive or low prices

C. Managing market value to enhance project visibility

In addition to providing liquidity, market makers also help project teams formulate token pricing strategies and assist teams in cashing out. The cooperation terms and contracts between market makers and project teams specify the rights and obligations of both parties, including reserve requirements, cooperation periods, profit sharing, and other matters. Overall, the cooperation methods and terms between project teams and market makers may vary depending on the specific circumstances of both parties. Cooperation should be based on consensus and compliance with relevant legal frameworks. Market makers will choose well-known projects to cooperate with to increase brand exposure, and project teams will also choose reputable market makers to increase the success rate of their projects. It is worth noting that many market makers are also investment institutions, which allows them to provide better support for investment projects while acting as market makers.

3) Relationship between Market Makers and Trading Platforms

Liquidity is the fundamental infrastructure of a trading platform, so the platform will provide many benefits to market makers, such as fee discounts, leverage funds, deposit and withdrawal limits, internal API channels, and institutional client accounts / accounting systems. These benefits are designed to attract and support market makers to provide liquidity support to the trading platform.

It should be noted that different platforms may have different requirements and cooperation models for market makers. Some platforms may specify specific market maker partnerships, and projects must cooperate with designated market makers to list after they go live.

As the top of the food chain in the cryptocurrency industry, market makers do not guarantee profitability and also face market risks and liquidity risks. The previous collapse of Luna caused a chain reaction that led to the collapse of market makers and the depletion of market liquidity. However, this is also related to the imperfect regulation and lack of transparency in the industry, as well as various issues such as misappropriation of user funds and arbitrary leverage. Alameda Research is a typical representative of this.

Mainstream Market Makers

There are many market makers in the cryptocurrency industry, but due to the significant difference between the cryptocurrency market and traditional finance, it is easy for market makers to form a monopoly when cooperating with trading platforms. The market liquidity is dominated by several large market makers. Here, we introduce several currently well-known ones (many market makers for projects are not public, so only some are listed):

• Jump Trading: A high-frequency trading giant established in 1999. Market making projects: Solana ecosystem, various dexs, LUNA, MASK, LDO, etc;
• Wintermute Trading: A digital asset algorithmic trading company established in 2017. Market making projects: OP, BIUR, ARB, etc;
• DWF Labs: A global Web3 venture capital and market making company that suddenly entered the public eye in 23 years. Market making projects: CFX, MASK, ACH, FET, YGG, and recently accused of market manipulation due to significant fluctuations in projects such as YGG and DODO;
• Sigma Chain: A cryptocurrency buying and selling company registered in Switzerland, and the SEC referred to CZ as its actual owner in a lawsuit file against Binance;
• Galaxy Digital: A cryptocurrency and blockchain asset management company established in 2018;
• B2C2: A cryptocurrency financial services company established in 2015, engaging in the trading and market making of cryptocurrencies globally;
• GSR: A cryptocurrency financial services company established in 2013, headquartered in Hong Kong;
• Amber Group: A global cryptocurrency financial technology company headquartered in Hong Kong, established in 2017.

The market making services and specific details of many projects are undisclosed. Many statements are leaked from interviews with market makers and are mostly in a “silent prosperity” state. After all, if ordinary investors know who “cut” them, their reputation is not guaranteed, so it’s better to remain hidden. Just like the previous WLD market making-related information and various details, they were dug out by netizens from various details.

Summary

Above is the relevant content about market makers. As key participants in the cryptocurrency market, market makers play an important role in maintaining market liquidity, improving market efficiency, and reducing costs. For investors, understanding the relevant knowledge about market makers will be helpful for participating in the market.

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