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Warriors across bull-bear cycles: crypto market makers
Summarized by AI
Original source: Huobi Research
Summary
The business of traditional financial market makers began to sprout in the early 19th century, and now it has shown the characteristics of mature development, diversified transaction types, and relatively stable business and income. As an important participant in the financial market, market makers have played a unique role in providing market liquidity and market efficiency. With the continuous expansion of the market size, more and more institutions and investment banks have also joined the market-making business and become an important source of income. The market-making business of the overall market also gathers to the head, and the competition is fierce. In order to seize the market and customers, market makers are constantly upgrading algorithms, technology, risk control, and compliance, and are gradually getting involved in the encryption field.
Compared with traditional finance, the encryption market market maker business is not much different in essence. But the operating model, technology, risk management and supervision are very different. First of all, in terms of market size, the encryption market is still relatively small compared to the traditional financial market, and the market size of the encryption industry is also relatively small. The liquidity of the encrypted market is relatively low and fluctuates greatly, and market makers need to be more cautious in risk management; secondly, the market maker team in the encrypted market is also called a banker. Because the trading process of the encrypted market is difficult to be supervised, and there is no strict market maker system to constrain it. The relationship between trading platforms, project parties and market makers has become more complicated. Then, the market maker business is not only generated on the centralized trading platform, but also involves market making on the chain, and based on this, some middleware and protocols for market making services have begun to appear; the last point is that in terms of technical architecture, the encryption industry Higher technical capabilities are required to ensure the security of transactions.
The market-making business in the encryption market is a blue ocean, which gives every investor opportunities but also comes with risks. At present, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are tightening supervision on the encryption market, and many institutions and businesses are affected. Coupled with the bear market and frequent thunderstorms of large institutions, it is even more challenging for market makers to manage risks. Beyond that, crypto market makers face market fragmentation/interoperability, capital inefficiency, regulatory uncertainty, and still-improving exchange technology/connectivity.
Even so, crypto market traders still have a lot of room for development and profit. Encrypted market makers will also present some development characteristics of traditional financial market makers in the future: (1) market-making participants are gradually diversified; (2) market-making varieties are diversified; (3) business leverage is high; (4) market-making The business head effect is becoming more and more obvious. In the field of investment, you can focus on centralized small market-making strategies or service projects, tools to solve interoperability, and CeDeFi projects.
1. Traditional market maker track
Do Market makers refer to institutions or individuals that provide liquidity in financial markets. Its main responsibility is to provide liquidity and market depth for the securities trading market. A market maker typically trades between buyers and sellers in a securities exchange market and provides a quote on the market so that other traders can place a buy or sell trade on that quote. Market makers are usually composed of investment banks, securities companies or professional institutions. They play an important role in the market and help to maintain market stability and liquidity. Market makers typically trade in one or more markets simultaneously and provide liquidity by buying and selling the same asset in order to provide trading opportunities to market participants.
The main goal of market makers is to profit from price differences when asset prices fluctuate, so they often use algorithms and other techniques to analyze the market, find opportunity, and trade quickly. Market makers may trade in various markets such as stocks, foreign exchange, commodities, bonds, etc.
Figure 1. Market maker system< p>
1.1 Industry overview
1.1.1 Industry functions and service customers< br>
The role of market makers in the financial market is very important, which is unique from other market participants. Especially in terms of providing liquidity and market efficiency. Specifically, market makers undertake six main functions:
Provide liquidity: Provide liquidity between buyers and sellers to make the market more active.
Continuous quotation: Market makers continue to quote, and provide buying and selling prices at any time, which is convenient for market participants to trade.
Manage risk: Market makers need to manage transaction risk, maintain a healthy risk-benefit ratio, and protect the interests of themselves and their customers.
Provide consultation: Market makers can provide market information and analysis to help customers make better trading decisions.
Increase market efficiency: The existence of market makers can increase market efficiency, reduce the price difference between buyers and sellers, and improve market efficiency and competitiveness.
Provide innovative products: launch new products according to market demand to meet the different investment needs of customers.
The customers of market makers mainly include the following categories:
Traders: Market makers provide liquidity to traders and help them conduct fast and efficient transactions.
Investment institutions: Market makers provide liquidity and services for investment institutions, helping them with asset allocation and risk management.
High-frequency trading firms: Market makers provide liquidity and services to high-frequency trading firms, helping them conduct fast, high-frequency transactions.
Individual investors: Market makers provide individual investors with liquidity and services to help them trade stocks, futures and other financial products.
Other financial institutions: Market makers also provide liquidity and services to other financial institutions, such as banks and insurance companies.
1.1.2 The development history of the market maker track
The development of the market maker track can be divided into five stages:
Before the 19th century: the initial stage of market makers, matching transactions in the traditional counter market. The market-making system is one of the oldest securities trading systems. It originated from the traditional over-the-counter market. In order to facilitate transactions and reduce transaction costs, traders assume the role of market makers themselves and provide bilateral quotations for other traders or customers. Most of them are traditional methods such as on-site communication and telephone communication.
19th Century-1970s: Standardized trading platforms appeared and developed rapidly, and market makers provided liquidity in the market. After the 19th century, major U.S. trading platforms such as the U.S. trading platform and the Chicago Stock Exchange were established one after another. At that time, market makers were mainly active on the New York Stock Exchange (NYSE). During that period, market makers were largely based on human trading, not computer programs. The market maker will list the quotations of buyers and sellers on the trading book of the securities trading platform, and provide market liquidity based on this.
1970s-80s: With the development of computer technology, market makers began to gradually apply electronic trading systems, which made transactions faster and more efficient . In the 1970s and 1980s, the trading volume of market makers increased rapidly, and their trading strategies and techniques were constantly innovated and optimized.
1990s: In the late 20th century, with the rise of institutional investors and retail discount brokers, the market share of market makers’ internal matching platform transactions continued to increase. On the one hand, with the rise of institutional investors such as mutual funds and pension funds in the United States, institutional investors’ demand for large transactions has increased significantly, and large investment banks represented by Goldman Sachs can provide comprehensive services for institutional investors. On the other hand, the volume of retail securities transactions undertaken by retail discount brokers such as Robinhood and Charles Schwab has surged, and such discount brokers mainly transfer orders to market maker platforms in exchange for market maker Payment for this (called Payment for Order Flow). With the globalization of financial markets, market makers have begun to expand their operations globally, while also facing increasing competition. During this period, market makers began to adopt more complex and advanced trading strategies and techniques to improve trading efficiency and profitability.
21st century: With the continuous innovation and development of financial markets, the role of market makers has gradually been expanded and consolidated. In the 21st century, market makers began to enter emerging markets, such as the cryptocurrency market and options market, while also adopting more advanced technological means, such as artificial intelligence and machine learning.
1.1.3 Market Size and Competitive Environment
Trading volume ratio: The trading volume ratio of a market maker in a certain market can reflect its trading activity and influence in the market.
Quotation depth: The quotation depth of a market maker in a certain market, that is, the quantity and price it is ready to trade, can reflect the degree of mobility.
Transaction efficiency: The transaction efficiency of a market maker in a certain market, that is, its ability to conduct transactions quickly and efficiently.
In short, the market share of a market maker is an important indicator, which can reflect its trading activity in the market, liquidity provision ability and transaction efficiency, etc. aspects of performance.
The more well-known market maker companies are as follows:
Jane Street: Headquarters A quantitative trading company located in New York City, USA, established in 2000, mainly focusing on trading in stocks, futures, foreign exchange and other fields.
Citadel Securities: a financial company headquartered in Chicago, USA, established in 2002, is one of the world's largest market makers, mainly involved in stocks, futures, Transactions in foreign exchange, bonds and other fields.
IMC Trading: A financial company headquartered in Amsterdam, the Netherlands, established in 1989, is one of the world's leading market makers, involving stocks, futures, foreign exchange, etc. domain transactions.
Optiver: A financial company headquartered in Amsterdam, the Netherlands, founded in 1986, is one of the world's largest options market makers and also involves transactions in other fields.
Susquehanna International Group: a financial company headquartered in Philadelphia, USA, established in 1987, is one of the world's largest option market makers, and also involves other fields transaction.
Jump Trading: A quantitative trading company headquartered in Chicago, Illinois, USA, established in 1999. The company is committed to using advanced algorithms and advanced technology to conduct transactions in order to find profit opportunities. Jump Trading involves various markets such as stocks, futures, foreign exchange, and digital currency on a global scale.
1.2 Necessary conditions for a market maker company
Establishing a market maker company requires High financial strength, technical ability and market insight, while meeting the regulatory requirements of financial regulators, and facing a highly competitive market environment and high risk management pressure, it is difficult.
1.2.1 Understand the market
do Market makers need to have an in-depth understanding of market rules, liquidity, trading varieties and traders' behavior patterns in order to make correct trading decisions. They need to understand the trends and opportunities in the market in order to gain an edge in the market. There are several ways to understand the market:
Research market information and data: market makers need to study the history and current transaction data of the market in order to understand the market and Prices fluctuate. Market makers can obtain market information by using trading software or market data providers.
Following News and Events: Market makers also need to be aware of market-related news and events, such as corporate earnings reports, political situations, and macroeconomic data. This information may have an impact on market prices and help market makers make better decisions.
Communicate with other traders: Market makers can learn about market conditions by communicating with other traders. For example, they can attend trading conferences or online forums to exchange ideas and market updates with other traders.
With the help of trading strategies and models: Market maker firms can use trading strategies and models to predict market trends and price fluctuations. These models may include methods such as technical analysis, fundamental analysis and quantitative analysis.
1.2.2 Establish a technical platform
Market maker companies need an efficient and stable technology platform that can support real-time trading and data analysis. The platform needs to include algorithms for fast execution of transactions, high-speed data transmission and processing systems, and secure transaction settlement systems. Specifically, a market maker company needs to have the following five types of technologies:
Trading technologies: including securities, futures, options, etc. These technologies include the use of trading platforms, order management, risk control, etc.
Data analysis technology: understand market conditions and trends. These techniques include data mining, machine learning, artificial intelligence, etc.
Quantitative trading technology: realize high-frequency trading and fast trading. These techniques include algorithmic trading, high-frequency trading, programmatic trading, and more.
Risk management technology: to ensure the safety and stability of transactions. These technologies include risk control, fund management, market monitoring, etc.
Software development technology: developing and maintaining trading systems and trading tools. These technologies include programming languages, database management, software testing, and more.
1.2.3 Determining Capital Needs
Market maker firms require substantial capital to support their trading activities. You need to determine how much capital you need to enter the market and identify sources of capital. Here's how to determine how much capital you need:
Calculating Market Liquidity Needs: Market liquidity needs are the amount of money a market maker must provide in order to trade Buy and sell transactions are performed on the market. The method of determining liquidity needs includes measuring market trading volume, trading frequency, and open interest and other indicators, so as to estimate the amount of funds that need to be invested.
Consider Margin Requirements: Many trading platforms and marketplaces require market makers to provide margin to ensure compliance with market makers' trading activity in the market. You need to understand the market margin requirements and reserve enough funds to meet the margin requirements.
Consider transaction costs: transaction costs refer to the fees that need to be paid on the trading platform in the market, including handling fees, quotation spreads, clearing fees, etc. You need to calculate transaction costs and set aside enough funds to cover those costs.
Consider market volatility: Market volatility can cause market makers to suffer losses. You need to take market volatility into account and reserve enough funds to cover market risks.
To sum up, to determine how much capital a market maker needs needs to consider a variety of factors, and it needs to be analyzed and calculated according to the specific conditions of different markets. It should be noted that capital demand is a dynamic process that needs to be constantly adjusted according to market changes and company business expansion.
1.2.4 Implement Risk Management
Market makers need to manage risk to ensure the safety and stability of transactions. You need to develop risk management strategies, including transaction risk, liquidity risk, market risk and operational risk, etc.
Market risk management is to ensure that the normal operation of the transaction can still be maintained under adverse market conditions. For example, market makers can employ measures such as hedging strategies, leverage controls, and trading restrictions to manage market risk. Operational risk is to ensure that errors or mistakes do not occur during the trading process. For example, market makers can establish good trading processes and trading rules, and strengthen measures such as internal audit and monitoring to manage operational risks. Technical risk management is to ensure the stability and security of the trading system. For example, market makers can employ measures such as backup and recovery strategies, network security measures, and data encryption to manage technical risk. Credit risk management is to ensure that there will be no default or loss of non-performing assets during the transaction process. For example, market makers can manage credit risk with measures such as credit assessment and monitoring, margin management, and risk control.
1.3 Operation Mode and Market Making System
On the trading platform, market makers pass Two-way quotation (buy and sell) to provide liquidity, so its operation mode generally includes the following steps:
Select the target: according to the trading strategy, Cooperation mode and risk preference Select one or more markets or products, such as stocks, futures, foreign exchange, etc.
Analyze the market: analyze the selected market or target to understand its characteristics, trends and changes. And specify the corresponding strategy according to the analysis results.
Provide quotations: Market makers will provide two-way quotations, that is, buying and selling quotations, according to their trading strategies and market conditions, to provide liquidity.
Trade Acceptance: A market maker accepts buy and sell orders from customers and executes trades based on their own quotes. In some cases, market makers may hedge to reduce risk.
Risk control: Market makers will monitor and control transaction risks, and conduct risk management and hedging operations as needed.
Profit: Market makers make profits through transaction spreads and handling fees, but there are also risks that may lead to losses.
Figure 2. Market maker operation mode in the trading platform
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Under the above operation mode, there are actually two driving systems: quotation-driven system and order-driven system. In the quote-driven system, market makers provide investors with bilateral quotes for buying and selling for gambling transactions, and guide the transaction price to change through the update of quotes. The order-driven (Order driven) system is also known as the auction trading system. Investors transmit the buying and selling orders to the trading platform through the network, and the computer host of the trading platform matches the buying and selling orders into transactions according to the principle of time priority and price priority, forming continuous transactions. price.
1.4 Profit Model
The profit model of a market maker is usually obtained from the bid-ask spread profit. The market maker will quote both buying and selling prices on the trading platform at the same time, which is called "two-way quotation". When a customer places an order, the market maker will immediately execute the transaction, and then sell at a higher price or buy the same security at a lower price to obtain a profit from the difference. This difference is usually called Spread income or Facilitation revenues. . Market makers can also make profits through high-frequency trading, hedging, and arbitrage. Among them, high-frequency trading refers to a trading strategy that uses high-speed algorithms and automated systems for fast trading. Hedging refers to using opposite transactions to reduce risk, and arbitrage refers to taking advantage of different prices in the market to obtain profits. In addition, market makers also have a kind of inventory revenue (Inventory revenues), which reflects the gains and losses brought about by changes in securities values when market makers hold positions, as well as dividends, interest and other holding income.
The level of profitability usually depends on factors such as market volatility, liquidity and transaction size. In the case of a stable market and sufficient liquidity, market makers are usually able to obtain considerable profits.
The profit of a market maker also needs to consider the transaction costs. The cost of the market-making business mainly includes three aspects: brokerage commissions paid when buying and selling securities, clearing fees and other transactions Costs; financing costs for raising capital for market-making business; costs of hedging to reduce the risk exposure of holding assets, and risk costs such as credit risks and counterparty risks that cannot be eliminated. However, since market makers usually conduct a large number of transactions, they can reduce transaction costs through economies of scale and efficient technology, and gain profits from it.
Spread income is the main income of market makers. According to public data, the profitability of most market makers is relatively stable, but the profit margin is not high.
Figure 3. Schematic diagram of market maker revenue and cost accounts (source: Committee on the Global Financial System, Ping An Securities Research Institute)
1.5 Regulatory and compliance requirements
Market makers are directly involved in the liquidity and price formation of the securities market, and their trading strategies and behaviors may have an impact on the market, so they need to be supervised by regulators. Supervision can effectively ensure that market maker companies abide by trading rules and market order, prevent market manipulation and improper trading behavior, protect the interests of investors, and maintain the fairness, transparency and stability of the market. At the same time, supervision can also promote the compliance operation of market maker companies, strengthen the requirements for risk management and information disclosure, improve market confidence and transparency, reduce market volatility, and promote the healthy development of the market. Therefore, it is necessary for market makers to be regulated not only to protect the interests of investors, but also to maintain the healthy operation of the entire market.
Here we mainly consider the regulatory policies of market maker institutions in the United States. In the United States, the supervision of market maker companies is relatively strict. These companies need to strictly adhere to the regulatory requirements of the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), and comply with securities regulations. In addition, market maker firms also need to comply with compliance and anti-money laundering requirements. Regulatory agencies strictly supervise the transactions and business of market maker companies, including the review of trading systems and algorithms, the inspection of risk control systems, and the requirements for data protection. In terms of regulation, the U.S. securities market has a sound regulatory system, and there will be corresponding penalties for violations. Therefore, market maker companies need to attach great importance to regulatory compliance risks in their daily operations. The specific departments and regulatory laws are as follows:
The United States Securities and Exchange Commission (SEC): Responsible for the supervision of the securities market, including the registration and supervision of market maker companies.
Financial Industry Regulatory Authority (FINRA): Responsible for regulating securities broker-dealers and market-making firms to ensure compliance with securities regulations.
"Securities Exchange Act" (Securities Exchange Act): The main regulations stipulate the operating rules and regulatory requirements of the securities market.
"Securities Act" (Securities Act): stipulates the registration and issuance requirements of securities, and involves the business of market makers.
National Securities Markets Improvement Act (National Securities Markets Improvement Act): The regulation of securities markets has been comprehensively revised, and market makers business is affected.
1.6 Future Development Trend
A market maker is a The developed circuit plays an important role in the financial market. With the development of the financial market, the market demand for market makers will continue to exist. However, at this stage, the development is relatively mature, and the market is gradually becoming saturated. It is difficult for new institutions to squeeze into this track. Therefore, more and more market maker teams use the encrypted market as their main layout point.
In general, the long-term challenges facing the market maker track are as follows:
Technical risk: As the market continues to change, market maker companies need to continuously upgrade and improve their technical architecture to ensure the stable operation of the system and avoid risks and losses caused by technical problems.
Legal risk: Market maker companies need to abide by the laws and regulations of various countries, including financial supervision, securities laws and intellectual property laws, otherwise they will face legal sanctions and loss.
Market risk: Market changes and uncertainties will bring risks and challenges to market maker companies, such as market volatility, declining trading volume, insufficient liquidity, etc. Any problem will affect the profitability of the market maker company.
Competition risk: With the intensification of market competition, market maker companies will face competition from other market maker companies and emerging technology companies, and need to continuously improve themselves core competitiveness, maintain market position and profitability.
Operational risk: market maker companies need to process a large amount of transactions and data, and need to establish an effective risk management and internal control system to prevent internal operational errors or violations resulting risks and losses.
Opportunities and challenges coexist. With the continuous development of the global financial market and the increasing complexity and scale of securities market transactions, market maker companies will have more opportunities to participate in the market by providing liquidity services and market manufacturing, so as to obtain higher profits. Moreover, with the rapid development of the encryption market, market maker companies can also obtain more opportunities by providing market manufacturing services and liquidity provision for encrypted assets. At the same time, market maker companies can improve their market manufacturing capabilities by developing and applying new technical tools and algorithms, better adapt to market demand, and gain more market share.
2. Encrypted Market Makers
Encrypted market makers and traditional finance There is not much difference in essence, they all provide liquidity for the market, quickly open and close positions, and obtain bid-ask spreads. But the operating model, technology, risk management and supervision are very different. First of all, in terms of market size, the encryption market is still relatively small compared to the traditional financial market, and the market size of the encryption industry is also relatively small. Secondly, the liquidity of the encryption market is relatively low and the volatility is high, and market makers need to be more cautious in risk management; then, the market maker team in the encryption market is also called a banker. Because the trading process of the encryption market is difficult to be supervised, and there is no strict market maker system to constrain it; the last point is that in terms of technical architecture, the encryption industry needs to have higher technical capabilities to ensure the security of transactions.
Market makers in the encrypted market play an important role, including: (1) providing liquidity and depth to the encrypted market; (2) providing stability to the market The price attracts more traders. It can be said that market makers are the key link for project parties, trading platforms, and investors to operate normally in the encryption market.
2.1 Development history
The development of market makers in the encryption market can be divided into 3 stages :
Early days (2009-2012): With the birth of Bitcoin, the first cryptocurrency trading platforms and market makers began to emerge. These market makers are primarily composed of individuals and small teams that aim to provide liquidity and trading opportunities.
Development period (2013-2017): With the continuous development and maturity of the cryptocurrency market, more and more institutions have begun to pay attention and intervene. Trading platforms and market makers have gradually become the focus of major institutions. During this period, some professional market makers began to appear and began to provide more professional and efficient services. Some representative companies that have emerged include: Cumberland Mining, Jump Trading, DRW Trading, and more. These companies not only provide market-making services, but also provide arbitrage, asset management and other services.
Great change period (2018-present): The slump in the cryptocurrency market in 2018 led to the collapse of many trading platforms and market makers, but at the same time brought Here comes an opportunity and a shuffle. After integration and adjustments, the trading volume of the cryptocurrency market has gradually recovered, and the services and models of market makers have also been continuously optimized and upgraded. At the same time, with the continuous introduction and improvement of policies and regulations in various countries, the supervision and compliance of encrypted market makers has gradually become an important trend in the market. At this stage, some traditional financial companies began to get involved in the cryptocurrency market, such as Jane Street, Susquehanna, etc.
Currently, the services of encrypted market makers are not limited to trading platforms, but have gradually expanded to over-the-counter transactions and decentralized trading platforms, providing market Development and maturity provide important support and security.
2.2 Encryption Market Maker Operation Mode
Encryption Market Maker Operation Mode and Similar to traditional financial market makers, they mainly provide liquidity and market depth for the cryptocurrency market, while earning profits from it. Encrypted market makers usually trade on multiple trading platforms, and the trading of encrypted market makers is usually automated and connected to the trading platform through an API interface. In the market, quotes are provided through their own funds and algorithmic models to attract buyers and sellers to trade. Some crypto market makers also offer over-the-counter trading services, allowing bulk and customized trades. Due to the volatility and uncertainty of the encrypted market, encrypted market makers need to adjust their market strategies in real time, including transaction size, quotation range, and hedging risks.
The encrypted market-making process generally includes the following steps:
Screening currency pairs: select One or more groups of currency pairs, usually depending on market liquidity and the volume capabilities of the market maker.
Quotation: Formulate buying and selling prices and publish them in the trading depth table of the trading platform.
Matching transaction: Once a trader is willing to match the quotation of the market maker, the market maker will immediately match the transaction and complete the transaction.
Risk management: Risk management is a very important step during market maker transactions. Market makers will use various tools and strategies to control their own risks. Such as trading limits, stop loss orders and hedging etc.
Settlement and liquidation: Once the transaction is completed, the market maker needs to perform settlement and liquidation, including charging fees to buyers and sellers and paying relevant taxes and fees.
Figure 4. Encrypted market-making business operation mode
In addition to the above steps, market makers also need to constantly monitor market conditions, including market liquidity, competitors' actions, and market risks, in order to adjust their strategies and quotations in a timely manner.
2.2.1 Market Making Strategy
The market-maker strategy is a risk-neutral spread arbitrage strategy, which belongs to the high-frequency trading strategy in the quantitative trading strategy and follows the principle of buying low and selling high. The basic principle is: between the selling price and the buying price of the market, insert a commissioned buy order and a commissioned sell order. If the inserted two orders are all executed, the market maker will get the price difference between the bid and the order, and the entire After the process, the positions held by the market makers do not change. If there is still a surplus after deducting various transaction fees from the price difference between the buying and selling orders, then the market maker has obtained a corresponding profit. Common market-making strategies include spread strategies, hedging strategies, quantitative trading strategies, etc.
Market-making strategies are divided into spot market-making and futures market-making strategies according to different markets. The spot market-making strategy has four modules: short-term trend judgment, market making, rebalancing and main cycle. Futures market-making strategies are more complicated, including complex logic such as market-making timing selection, net position processing, lock-up, shifting, and counterparty lightening.
2.2.2 OTC transactions
The way crypto market makers provide over-the-counter trading services is usually by establishing contact with counterparties and negotiating prices and transaction details with them. Specifically, encrypted market makers will publish their market-making prices on trading platforms or other off-exchange channels, waiting for counterparties to accept and trade. In addition, encrypted market makers can also use their own liquidity pools to provide real-time quotes and trading opportunities to counterparties when needed to meet their liquidity needs. At the same time, encrypted market makers can also provide clearing and settlement services for counterparties to ensure the smooth progress of transactions and the safety of funds.
2.3 Market-making technical threshold
Encrypted market makers need to compete with traditional market makers Technically, they overlap completely, but encrypted market makers need to master more technologies, the most important being blockchain technology. Cryptocurrency transactions are based on blockchain technology, so crypto market makers must understand blockchain technology and its application in cryptocurrency transactions in order to understand the nature and technical details of transactions. Learn how exchanges and wallets interact with the blockchain, and how to identify and resolve issues such as transaction delays due to network congestion or other issues.
Secondly, for the encryption industry, asset security is also very important. Due to certain security risks in cryptocurrency transactions, encrypted market makers need to master relevant security technologies to protect the security of the trading system. Specific technologies include multi-signature technology, cold wallet storage, secure communication protocol, transaction monitoring and anti-fraud technology, data backup and recovery technology, etc.
Other technologies are not limited to:
Digital currency trading platform API: encrypted market maker needs Master the digital currency trading platform API (application programming interface) in order to connect with the trading platform and obtain market data, perform trading operations, etc.
Data analysis and machine learning: The cryptocurrency market fluctuates greatly, so encrypted market makers need to have certain data analysis capabilities, including market analysis, price trend forecasts, etc. Machine learning technology can help market makers make more accurate trading decisions.
Social media and online marketing: The cryptocurrency market has strong social characteristics, so encrypted market makers need to have certain social media and online marketing capabilities. To interact and communicate with potential customers.
2.4 Trading platform and market maker
The relationship between the digital currency trading platform and the market maker team subtle. Some crypto exchanges may have their own team of market makers, but many also choose to work with third-party market makers. There are two forms of cooperation between trading platforms and market makers:
Direct cooperation with encrypted trading platforms
Market makers cooperate directly with encrypted trading platforms to provide on-site market-making services. The trading platform will often provide some market maker plans, which require the cooperation of these teams and provide trading interfaces, but these are passive trading interfaces and cannot take the initiative to take orders. If you want to actively quote and take orders, you can only do it inside the trading platform, directly or indirectly embedded in the matching system of the trading platform.
At this time, market makers need to obtain information such as the order book and market depth of the trading platform through the API interface, and then use their own algorithms and trading strategies for market pricing and deal matching.
The trading platform needs to provide market makers with relevant module interfaces, usually including market data, order withdrawals, recharge reminders, etc.
Indirect cooperation with encrypted trading platforms
Market makers cooperate with Canadian trading platforms through other intermediaries or platforms to provide off-exchange market-making services. At this time, the market maker needs to negotiate with the intermediary or platform to determine the cooperation method and details, and obtain the market information of the trading platform through the API interface or other channels, and then conduct off-exchange transactions.
It should be noted that crypto trading platforms do not have to use market makers to provide liquidity. Some trading platforms may use other methods to increase liquidity, such as using technologies such as deep pools or order book matching engines. When cooperating with an encrypted trading platform, market makers need to negotiate with the trading platform on cooperation details, fee allocation, transaction volume, etc., to ensure smooth cooperation and obtain considerable benefits. At the same time, market makers need to strictly abide by the rules and regulatory requirements of the trading platform to ensure the legal compliance of transactions.
From the analysis of the trading mechanism, the market makers connected with the trading platform are largely involved in the price determination process, which can restrain the attempts to manipulate the currency price to a certain extent people, improve the expectations of investors and project parties, and stabilize market sentiment.
The existence of market makers has played a role in promoting the liquidity of the trading platform. The higher the liquidity of a trading platform, the better the user's trading experience, the stronger the user stickiness, and the more profits the trading platform can make. Therefore, the trading platform is willing to give rebates to some people who specialize in market makers.
Around 2017 and 2018, a large number of new trading platforms went online, leading the concept of "trading is mining". 120% cashback based on trading volume is used to attract market makers to participate in trading.
In order to attract more excellent market maker teams to make markets on the trading platforms, all major trading platforms have launched their own service solutions. First of all, the trading platform itself needs to have more service products, including more spot trading pairs and futures types, value preservation products (low interest rate lending services, etc.), and provide more trading strategies and algorithm services. Secondly, a reasonable and attractive rebate ratio. In the end, the risk management and reputation of the trading platform is the most important. Here are some of the activities provided by the trading platform for market makers.
Table 1. Market maker activities of each trading platform
From the list of activities above, it can be seen that Gate will launch a global market maker in 2021 After the plan, there will continue to be market maker competitions to attract market maker teams. At the same time, the market-making fee rate and GT positions are constantly being adjusted. In addition, some services are also provided for market makers, including 0-interest loan lines.
Market makers will participate in the spot, futures, and options markets, and the threshold is getting higher and higher. Correspondingly, the trading platform will also grant different privileges in different participating markets. In general, the trading platform can give discounts to market makers in the following items:
Service fee discount
Leveraged funds
Amount of deposit and withdrawal
API internal channel
Institutional client accounts/accounting system
For market traders, handling fees are particularly critical. Especially the high-frequency trading process. Of course, in the initial stage of the trading platform, it is very likely that some market makers will be hired to make markets, especially futures and options.
2.5 Project parties and market operators
Figure 5. The relationship between market makers and participants
In the encrypted market, the liquidity of the project Token is as important as the product, team, and operation. The relationship between the project party and the market maker is mainly established through the market maker providing liquidity services to the project party. Project parties, especially new projects in the ICO or IEO stage, need a market maker team for price management. Market makers play three roles: (1) Make up for the shortcomings of insufficient market liquidity; (2) Stabilize currency prices to prevent project failure from being too high or too low; (3) Market value management to improve the market value of the project Recognition. These tasks are handed over to a professional market maker team, which costs less than the project team's own operations.
Due to the lack of supervision, market makers can drive trading volume by buying and selling in the market. Of course, this kind of "false" trading volume can attract the attention of some investors.
The project party will choose some well-known encrypted trading platforms to cooperate with market makers to obtain better liquidity and higher market recognition, which requires The project provides a certain number of tokens to market makers as initial circulation. Market makers agree to provide active liquidity to the order book for at least 90% of the contract term, and in exchange they receive 2-5% of the project’s total token supply. For market makers, cooperating with well-known project parties can improve their popularity and reputation in the market and help attract more trading pairs for transactions. Therefore, in the encrypted market, the cooperative relationship between project parties and market makers is very important.
In addition to providing liquidity, market makers will also provide additional services for project parties, including formulating Token price (especially STG) strategies and helping teams cash out
2.6 Profit model of encrypted market makers
Like traditional market makers, encrypted Market makers also make profits through the price difference between buying and selling transactions. However, in the absence of regulation in the crypto market, this spread can be large, the market volatile and the returns more volatile.
Encrypted market makers also have two sources of income: (1) helping project parties to make markets; (2) assisting trading platforms to maintain sufficient liquidity and trading volume .
Among them, in cooperation with the project party, the profit model of the market maker is usually the following two:
Market makers cooperate with project parties to become Token liquidity providers and participate in Token liquidity mining. When the liquidity of Token increases, market makers will receive Token in return. In addition, market makers can also gain benefits by providing market depth, participating in airdrops and promotions of project parties, etc.
Cooperating with trading platforms, there are also two profit models:
Market making rewards: some In order to attract market makers to participate in market making, the encryption trading platform will provide market making rewards. When market makers place orders in the market provided by the trading platform and have a certain trading volume, they can get rewards from the trading platform, which also becomes a way for market makers to earn income. This part can also be a transaction rebate.
Provide liquidity services: Market makers improve market liquidity by providing cryptocurrency trading services, thereby helping trading platforms attract more users and transactions quantity. Some crypto trading platforms pay market makers additional liquidity fees.
As the number of market makers increases and the competition becomes stronger, in order to win more markets, market makers will narrow the price difference between quotations, resulting in profit reduce.
2.7 Market Maker Evaluation Elements
How to choose a market maker team or evaluate market maker performance Crypto market participants are very important. Common indicators for evaluating a market-making team include the market maker's trading volume and trading frequency, the accuracy and stability of quotations, profit margins and risk management capabilities, market share and reputation. But for trading platforms, market takers, and project parties, what is more important is the performance of market makers in providing liquidity. Reference indicators for liquidity performance include quotation depth, accuracy, update frequency and transaction efficiency.
Simple indicators will be listed in the market maker activities of each trading platform, including the market maker's entrusted volume, bid-ask spread, quotation, and identification requirement coverage , market making time, etc. There are also some trading platforms that use more complex indexes, such as weight depth multiplier, liquidity index, etc.
3. Risk analysis and management of encrypted market makers
3.1 Supervision and Compliance
Crypto market makers are currently still in a regulatory gray area and are not yet supported by a clear legal and regulatory framework in most countries and regions. This means that crypto market makers are generally not required to adhere to the strict regulatory standards set forth in traditional financial markets, nor are they regulated by the corresponding regulators. However, in some countries and regions, regulators have begun to explore how to regulate encrypted market makers to ensure market transparency, fairness and stability.
Regulatory agencies involved in market makers in the encrypted market include the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Certain regulatory responsibilities, in which the SEC is responsible for supervising the securities nature of encrypted assets, and the CFTC is responsible for supervising transactions such as encrypted derivatives contracts. In addition, ESMA, the European Union's financial market regulator, has also begun to explore the regulatory framework of the encryption market, aiming to ensure the transparency and stability of the encryption market.
In recent years, the cases of these regulators include:
SEC ( SEC) announced in July 2020 that Coinbase and other encrypted trading platforms can register as brokers and trading platforms and provide market maker services for digital assets on their trading platforms. This shows that the SEC has begun to explore the regulation of encrypted market makers.
The Swiss Financial Market Supervisory Authority (FINMA) released a cryptocurrency management guide in 2019, which mentioned how crypto traders and market makers should cooperate regulations and need to apply for a license to engage in these activities. This shows that FINMA has begun to regulate crypto market makers.
Singapore Securities Exchange (SGX) launched the digital currency trading platform SGX iSTOX in 2020, and developed a regulatory framework with market makers to ensure their Compliant and transparent. This shows that SGX has begun to explore the supervision of encrypted market makers and has begun to cooperate with market makers.
These cases show that regulators have begun to explore the supervision of encrypted market makers and have formulated some relevant guidelines and regulatory frameworks. With the continuous development of the encryption market in the future, it will become increasingly important for regulators to supervise encrypted market makers.
In terms of compliance, encrypted market makers also need to comply with various regulations, which vary from country to country, but some common compliance requirements include:
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KYC (Know Your Customer): Market makers are required to comply with KYC regulations, ensuring that customers' identities are verified and recorded.
AML (Anti-Money Laundering): Market makers need to comply with AML regulations to prevent cryptocurrencies from being used for money laundering and other illegal activities.
Data Protection: Market makers need to comply with data protection regulations to protect the security and privacy of customer data.
Transparency of transactions: Market makers need to provide transaction transparency, including public transaction data, market depth and other information, to ensure fair and transparent transactions.
In addition, some countries or regions may have other regulatory requirements, such as regulations in the fields of taxation, securities or futures, etc.
3.2 Market Risk
Market makers face multiple risks in the crypto market, including :
Price risk: Due to the high volatility of the cryptocurrency market, market makers face price risk, that is, the market price of cryptocurrencies held by market makers Losses may occur during large swings.
Liquidity risk: Market makers need to provide liquidity to support market transactions, but if there is a large number of sellers or buyers in the market, market makers may It is difficult to provide sufficient liquidity in a timely manner, resulting in transaction delays or failures.
Counterparty Risk: Due to the anonymity and decentralization of the cryptocurrency market, market makers may not be able to determine the credit status and transaction intentions of their counterparties, thereby Exposure to counterparty risk, where a market maker fails to honor its counterparty's trades.
Market-making capital risk: Market-making capital is similar to traditional financial market-making. level. Especially when it comes to deposit and withdrawal, it is the first threshold for market making. The market-making team generally opens accounts with Silvergate bank and Signature bank. But the two crypto-friendly banks have recently faced bankruptcy, and many funds cannot be withdrawn. This increases the threshold for future institutions to enter the encryption field.
In order to deal with the above risks, each market maker will have certain strategies, such as In an extremely volatile market, it is more inclined to withdraw. Or use a risk hedging strategy to preserve the value of the position, and transfer the risk to the asset based on the inventory model and information model.
3.3 On-chain and off-chain risks
The off-chain risks are generally transaction risks. Such as the integrity of historical data, flaws in strategy model design, system failures, lack of risk control, overfitting, and transaction cost sensitivity risks.
Pricing risk: It determines whether the market maker can provide attractive prices, and whether the pricing is correct or not is directly related to the profit and loss of the market maker.
Inventory risk with huge asset price fluctuations: If the price of the underlying asset develops in a unilateral direction, for example, in an upward trend, the buy order is not executed after the sell order is completed, There is a risk that the selling price will rise. In a downtrend, if the sell order is not fully completed after the buy order is completed, you will bear the risk of the purchase price falling.
Trading platform risk: There are many kinds of trading platform risks.
The frequency and quantity of buying and selling orders are random, which may cause the risk that the buying order has not been fully completed after the selling order is completed.
There is a bug in the trading platform, there is a problem with the trading pair, and the trading platform has not opened the protection measures.
API Risk: This includes internal leak issues, API outages, etc.
The source of risk in the encryption market is not only the risk brought by off-chain transactions, but more possible risks come from the chain. First of all, if there are loopholes in the smart contract of the market-making Token and it is attacked by hackers, it will cause losses to the stock assets of the market maker. Secondly, encrypted market makers may need to participate in on-chain protocols, DeFi applications, etc. to provide liquidity, and all risks on the chain will be transmitted to every participant. For example, there is a fork in the public chain where the protocol is located or the speed of transactions on the chain slows down.
3.4 Risk Management
In order to control the above possible risks, the market maker will also set Set strict policies and disciplines.
Focus on transaction quality rather than quantity
Although market makers can provide trading platforms with Liquidity gets a certain commission, but excessive trading often wastes more time and money, so the key to effective trading is to choose the quality of the transaction rather than the quantity of the transaction. This is reflected in three aspects: (1) choose a good asset target; (2) choose a reputable trading platform; (3) analyze the market and determine an appropriate trading strategy.
Build a good working relationship. Market makers need to establish a good cooperative relationship with trading platforms, project parties, investors, etc. to obtain more information and support and reduce their own risks.
Strong discipline. This includes exit mechanisms, not using excessive leverage. Market makers need to control their own risk exposure and diversify risks as much as possible.
Inventory risk management. Maintains the proper position of inventory in continuous buying and selling. Inventory risk and its management promote the trading enthusiasm of market makers and are also the main reason for certain impact on market prices.
Using price change leverage to enable inventory to meet its continuous trading and cost reduction requirements. Through portfolio investment and hedging in the encrypted market.
Monitor the market. Market makers need to constantly monitor changes in market liquidity, including market depth, trading volume, trading counterparty and other indicators, and adjust their quotation strategies in a timely manner to ensure that there is sufficient liquidity support in the market.
4. Typical case analysis of encrypted market makers
In recent years, with the With the continuous development of the market, encrypted market maker companies are gradually rising. These companies are committed to providing services such as liquidity management, price discovery and transaction matching to meet the growing demand for cryptocurrency trading. At present, many professional crypto market maker companies have emerged around the world. They use various efficient technologies and strategies to provide market participants with diversified trading services, and promote the further development and maturity of the cryptocurrency market. Since the encryption market still has a big gap with traditional finance, it is easier for market makers to form a monopoly, and the liquidity of cryptocurrencies is dominated by several large market makers. This includes Jump, Wintermute, Amber Group, B2C2, DRW Trading.
4.1 FTX Thunderbolt and Alameda Research went bankrupt
Alameda Research was established in 2018, the headquarters Located in California, USA. The company was founded by mathematician Samuel Bankman-Fried. Samuel Bankman-Fried worked at Jane Street, where he gained extensive quantitative trading experience. In addition to market making and quantitative trading in the crypto market, the company has also developed some cryptocurrency trading tools and infrastructure, such as the crypto trading platform FTX and the crypto trading protocol Serum on the Solana blockchain.
After the FTX thunderstorm incident, Alameda Research went bankrupt, and the FTX market-making team suffered a lot of losses, as can be seen from Kaiko’s data BTC pending orders after the FTX incident, indicating a lack of liquidity. The digital assets of FTX and Alameda include FTT and SOL. The collapse of these Tokens has led to liquidity crunch and liquidation risks for all Tokens on the solana chain.
Figure 6. Kaiko BTC trading platform liquidity
4.2 Wintermute and DeFi hacking incident
Wintermute Trading is a London-based cryptocurrency market maker. The company was founded in 2017 by Evgeny Gaevoy and Harro Mantel. The main business of Wintermute Trading is to provide liquidity services for cryptocurrency trading platforms, institutions and individuals, and also provide market-making services in some cryptocurrency derivatives markets. At this stage, Wintermute has reached partnerships with more than 50 cryptocurrency trading platforms. And it is in the leading position in the trading volume ranking of each trading platform. The core members of the team include
CEO: Evgeny Gaevoy, who was in charge of the trading platform trading fund (ETF) business in the European market at Optiver before;
Chief Technology Officer: Valentine Samko, who has worked as a software engineer at trading firms and banks including Barclays and JP Morgan.
Figure 7. Bitfinex spot trading volume ranking
In addition to its business in the cryptocurrency market, Wintermute Trading is actively involved in promoting the development and regulation of the cryptocurrency market. The company is a member of the London Digital Asset Exchange Association (LSTA) and a member of the Association of Digital Asset Dealers (ADAM). In February 2021, Wintermute announced the completion of a $25 million financing round, with investors including Lightspeed Venture Partners and Pantera Capital, among others. But Wintermute's 2022 revenue will be around $300 million, down from $1 billion in 2021, thanks to the bear market and hacking.
In September 2022, Wintermute lost $160 million due to the theft of its EOA wallet due to possible use of the Profanity tool to create vanity wallets.
4.3 GSR Market
GSR Markets is fundamentally an algorithmic digital company belonging to Hong Kong trading company. It leverages its software to provide liquidity for order execution solutions for several digital asset classes. The company deploys multiple trading models, integrates with more than 30 liquidity pools, and its trading fees are relatively low in the market.
Characteristics:
Top-class leadership and strong technology from a world-class financial institution Team with financial practitioners.
Intuitive risk management strategies designed for those who find it hard to manage.
Its proprietary trading technology can be modified according to trading needs. Its sales and aggregation strategies are adjusted for real-time liquidity and volatility, allowing investors to truly get the best prices.
Recently, GSR has been cooperating frequently with various project parties. Including Stargate, Stargate will provide GSR with European options on 8 million STGs, provided that the average STG price exceeds $1.15 after 24 months. After the proposal passed, STG surged 36.2% in the past 14 days.
5. Decentralized market makers
Participate in on-chain market making. There are three forms of becoming a decentralized market maker: (1) Participating in the liquidity provider of the decentralized trading platform DEX, also known as mining behavior, the threshold is low, anyone can participate, and provide liquidity for trading pairs (2) Participate in the decentralized derivatives market, similar to the dydx model; (3) Some DeFi protocols that specialize in market making, such as Elixir, have become liquidity distribution tools for CLOB and AMM models .
DEX generally adopts the automatic market maker algorithm AMM, and anyone can become a market maker. It uses automated algorithms to balance the supply and demand of Tokens in the trading pool. The working principle of AMM is to allow liquidity providers to deposit Token (usually the same amount) into the liquidity pool. Then, the price of Token in the liquidity pool follows a formula, such as the constant product market maker algorithm x*y = k, where x and y are the number of two Tokens in the pool, and k is a constant. This results in the proportion of tokens in the pool determining the price, ensuring that regardless of the transaction size, the pool can always provide liquidity, and that the amount of slippage is determined by the transaction size compared to the pool size. As the price in the liquidity pool deviates from the global market price, arbitrageurs will come in and push the price back to the global market price. Various protocols iterate this basic AMM model or introduce new ones, such as Curve, Balancer, Uniswap V3, etc. providing improved performance and extending to derivatives.
But in DEX, there are also certain risks. LP needs to bear the risk of loopholes in the smart contract itself, the liquidity pool is emptied, and the problem of unpaid losses, etc. In the DEFI protocol, in order to attract LPs and professional market maker teams, different market-making strategies and liquidity pools are provided for selection, while giving higher yields. Even so, I think that on-chain market making and centralized trading platform market making still have their own advantages and disadvantages, and they cannot replace each other.
Another thing to mention is the special market-making protocol, here we take Elixir as an example. There are two main users of Elixir: (1) project parties; (2) users who want to become market makers. The specific implementation mechanism is as follows:
The project party can create bonds without permission in Elixir to obtain liquidity, which is similar to the mechanism of Olympus DAO. Users can obtain LPToken through the liquidity pool and convert it into the original Token of the project party to establish the liquidity of Token.
Provide users with specialized market-making strategies so that everyone can participate in market-making activities in CEX and DEX. While opening up the threshold of the city, it also opened up a niche track. However, since the market-making strategies, quantitative strategies, and risk management strategies are frequently adjusted and updated under different market conditions, the DeFi market-making agreement still needs time to verify, but for some users who want to obtain benefits from the market-making business That said, it's not a good way to say it.
Currently, centralized market merchants cannot cooperate with project parties in an open and transparent manner, and the commission is high, but the market-making agreement on the chain can effectively increase user funds Utilization rate, become a liquidity provider, solve the liquidity problem for the project side through appropriate algorithms and strategies, benefit users, and the project side can also achieve their goals. However, the market-making agreement mechanism on the chain is complex and inflexible, which may make it difficult to deal with market risks.
Development and Challenges of Encrypted Market Makers (with investment and financing list)
The rapid development of the encrypted currency market has prompted encrypted currency market makers The increasing demands of the industry have also given birth to more innovative technologies and business models. The future development trend of encrypted market makers is reflected in the following aspects:
Strengthening risk management: As the cryptocurrency market continues to mature and standardize, risk management will Become one of the important factors in the competition of market makers. Market makers need to adopt more scientific methods and tools to reduce transaction risk and credit risk, and ensure the safety and stability of operations.
Develop a more intelligent trading system: With the continuous advancement of artificial intelligence and machine learning technology, cryptocurrency market makers can adopt a more intelligent trading system , to improve efficiency and transaction quality, and better adapt to market changes and needs.
Strengthen liquidity: As more and more institutions and investors enter the cryptocurrency market, market makers need to continuously strengthen their own liquidity to meet More diversified and complex trading needs. During this process, market makers also need to work closely with other market makers, trading platforms, and liquidity providers to jointly promote the development and growth of the market.
Explore new business models: With the continuous development and changes of the cryptocurrency market, market makers need to constantly explore new business models to cope with market changes and challenge. For example, some market makers began to provide more professional services to the market, such as market making based on data analysis, cross-chain market making, etc. At present, many market makers have also begun to get involved in other encrypted businesses, such as custody, OTC business, primary investment, etc.
Actively try to make a market on the chain protocol: With the increase of projects and users on the chain, whether it is to cooperate with the project party or to obtain a higher rate of return , market makers will start to step into the chain. At the same time, there will be more and more market maker activities like dydx. In addition, the market will participate in more encrypted products that require liquidity. For example, the encrypted market maker GSR launched the NFT market-making project, which will focus on generative art. The company has purchased 175 pieces (NFTs), but is still working out how to trade them algorithmically.
The cryptocurrency market has many unique characteristics and faces various challenges when providing liquidity. kind of challenge. For example, the encrypted market is open 24/7/365, providing self-custody capabilities, retail directly interacts with the trading platform (the trading platform plays the role of broker, trading platform and custodian), and provides instant "settlement" of virtual balances in CEX, with Compared with traditional financial settlement, T+2 provides fast settlement of on-chain transactions on DEX, and uses stable coins to facilitate transactions, considering the volatility of BTC and the still clumsy conversion of fiat currency to cryptocurrency. Additionally, crypto markets remain largely unregulated, leading to the potential for price manipulation, and continue to be highly fragmented, with liquidity forked across many on-chain and off-chain venues. Additionally, trading venue technology is still evolving, as the quality of API connections to trading platforms can vary and periodically drop during periods of high market activity. Finally, the crypto derivatives market is still evolving, and compared to traditional financial markets, derivatives are much smaller relative to spot. These characteristics present various challenges in providing liquidity, including market fragmentation/interoperability, capital inefficiency, regulatory uncertainty, and still-improving exchange technology/connectivity.
In short, with the continuous development and changes of the cryptocurrency market, market makers need to constantly adjust their strategies and business models to better adapt to the market changes and needs. At the same time, market makers also need to strengthen cooperation and exchanges with other market participants to jointly promote the development and growth of the market.
< img src="https://image.theblockbeats.info/upload/2023-03-28/68c169c666ab2398df3ef012083f3250493eaac1.png?x-oss-process=image/quality,q_50/format,webp">
Table 2. Summary of investment and financing projects of encrypted market makers in 2019-2023
Summary and thinking
Whether it is a traditional industry or an encrypted market, market makers need to be in the market forever in order to trade with the "spread", so different markets mean more profit opportunity. Encrypted market makers will also present some of the development characteristics of traditional financial market makers in the future: (1) Market-making participants are gradually diversified, including comprehensive large-scale investment banks, electronic trading platforms, etc. (2) Diversified market-making varieties, including various spot products and derivatives. In particular, the crypto derivatives market is constantly evolving. (3) Business leverage is high. The market-making business represented by spot and derivatives transactions is a typical capital-consuming business. Most investment banks use leveraged funds to expand their business scale, so the leverage ratio of market-making business is often higher than other businesses. This tends to spawn other crypto lending businesses and raises the level of risk across the industry. (4) The head effect of market merchants is becoming more and more obvious. Head institutions have sufficient talent reserves, strong capital strength, rich customer resources, excellent pricing capabilities, and large asset scale. Risk costs can be reduced by diversifying asset portfolios and using hedging tools. Therefore, leading institutions have more advantages in market-making business.
Although the scale of encrypted market makers is expanding and the competition is becoming more and more fierce, in fact, the technical barriers of encrypted market makers are relatively high. Take a higher risk. Especially in the FTX thunderstorm incident, Cumberland, GSR, Wintermute, Jump, folkvang, Nibbio and other market players have positions in FTX. At the same time, it is still unclear how much impact the recent thunderstorm risk at Silvergate Bank will have on market traders. This shows that the efficiency of capital flow is particularly important to market makers.
As a trader, we also need to identify whether the market maker is cooperating with the project party to correctly judge the price trend of the Token, which can be obtained from the Token price and transaction Quantitatively found clues.
Decentralized market maker agreements, including DEX, are also constantly striving for some market making teams to participate in activities on the chain. In my opinion, the order book form can satisfy the various trading strategies of the market-making team, while the AMM form has certain limitations and is difficult to control. If there is a large profit advantage, the market making team will use part of the funds to participate in the market making on the chain. But I don't think it will threaten the status of centralized trading platforms. Of course, the influence of some innovative DeFi protocols cannot be ignored. It is worth noting that some market makers have begun to explore market making in the NFT field. They are also exploring more on-chain products or market-making derivatives with secondary trading markets.
However, a hidden danger is not ruled out here. Similar to Alameda, more large market-making institutions may take the initiative to incubate on-chain agreements, or DEX or lending, such as the DEX Bebop incubated by Wintermute. The strong capital they provide will promote the agreement itself, but it also brings risks to the entire market.
7.1 Thinking about investment direction
Market makers play an important role in the trading process, and their Profitability can have a lot of room to play in the bull-bear cycle. On the market maker track, you can focus on the following investment directions:
Centralized small market maker strategies or service projects, such projects are market makers Provide tools, data, and customized strategy services.
Solving interoperability issues: due to the development of public chains and Layer2, a multi-chain world is currently presenting, which leads to liquidity fragmentation. One potential solution is second-layer middleware providers that can trustlessly interact with different chains to find the most efficient transaction routes among many liquidity sources.
CeDeFi: The lines between CeFi and DeFi may merge, including liquidity provision.
This article is from a contribution and does not represent the views of Rhythm BlockBeats.
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