Crypto Market Making Explained: The Secret Keystone To A Token Project's Success

Even highly liquid markets experience high volatility. Crypto market making is, therefore, an essential element for crypto token projects.

This article will walk you through what things to keep an eye on when figuring out the optimal crypto market-making setup developed by us at Autowhale.

We’ve been a strong partner for clients in the crypto space. Some projects they have supported are token projects, including Presearch, Locktrip, or Blackhat.

Why market making is a crucial element for token projects

The list below describes the most important points when applying market-making strategies on token markets:

• Increased liquidity: By providing liquidity on a crypto exchange, market makers can help to maintain a tight bid-ask spread (i.E. the difference between the price at which an asset can be bought and sold) which makes it easier for market participants to buy and sell an asset. Increased liquidity can also help to reduce the volatility of the token price.

  
  

• Managing order flow: Market makers can also manage the flow of orders for a token by using algorithms to automatically buy and sell the token at predetermined prices based on predetermined criteria such as trading volume and price. This can help to smooth out the price movements of the token and reduce volatility. Market-making algorithms can manage order flows by supplying liquidity to key price levels. It is essential to distinguish between placing limit orders (liquidity) at important price levels and paying for order flow or having some backdoor to an exchange to frontrun certain orders. Of course, the latter is highly unethical, if not illegal, and should be avoided by token projects.

  
  

• Offsetting risk: Market makers can offset the risk of their positions by using various hedging techniques, such as futures contracts or options, to mitigate the impact of price movements on their positions. More on that later in the article.

  
  

• Enhanced price discovery: Market making can also help to improve the accuracy of price discovery or the process of determining the fair value of an asset. By applying market-making strategies, crypto market makers can provide information about the supply and demand for the asset, which can help to inform the market about the asset's value.

Offsetting Risks and the Alameda/FTX debacle

Offsetting risks is a key part of crypto market making. Token projects need to be aware of how to manage the inventory of their tokens and be responsibly exposed to the volatility of their asset(s).

Some crypto market makers, such as Alameda, allegedly were set up in a way that token projects provided them with tokens that did not have lockups. In such a setup, token projects are, on the one hand, at the mercy of the market maker to not dump their markets (therefore decreasing the overall inventory of the token project if risks are not offset correctly), and on the other hand, the incentives are not aligned.

Token projects should hire a market maker that operates in their (selfish) interest.

Crypto market makers like us work instead on a fixed price set up than taking a cut of the token supply.

Crypto market-making strategies for token projects

There are various strategies token projects can apply for crypto market making, depending on their goals and the characteristics of their token.

Here are a few examples of crypto market-making strategies that token projects may use:

• Simple market making: Simple market making involves continuously buying and selling the token at a fixed spread, or the difference between the buying and selling prices. This strategy can help to provide liquidity to the market and reduce the bid-ask spread, but it may be less effective in volatile markets.
• Adaptive market making: Adaptive market making involves using algorithms to automatically adjust the market maker's buying and selling prices based on market conditions, such as volume and price movements. This can help to maximize liquidity and reduce risk in changing market conditions.
• Dynamic market making: Dynamic market making involves using algorithms - may they are based on statistical/quantitative models or machine learning based - to continuously optimize the market maker's position based on various factors, such as market conditions, order flow, and risk. This can help to maximize liquidity and reduce risk in changing market conditions.
• Delta neutral market making: Delta neutral market making involves buying and selling the token so that the market maker's overall delta, or the sensitivity of the market maker's position to price movements, is zero. This can help to reduce the impact of price movements on the market maker's position and minimize risk. Regarding delta-neutral market-making for token projects, it is vital to consider the availability of derivatives of the respective token. If there are no derivatives, a crypto market-making firm may consider finding a basket of other derivatives – with a strong correlation to the tokens price - that may be used as a hedge for the token’s market.

Other strategies, such as arbitrage trading strategies, may need to be considered - especially when looking to make markets across multiple venues, including decentralized exchanges.

Ultimately the choice is to be determined on a case-by-case basis depending on the specific requirements of their business and the characteristics of their token.

How We Do Market-Making for Token Projects

We’ve tailored our solution to meet clients’ needs at scale – whether a token project is only getting started (by having their first secondary market listing) or is already established across multiple venues. Projects don’t even need specialized expertise or infrastructure.

1. Clients, from token projects to exchanges or funds working with Autowhale, start the onboarding by providing the required documents and contracts.
2. After figuring out the right setup (see “Offsetting Risks and the Alameda/FTX debacle”), the clients provide us with the required API keys for connecting to their exchange accounts.
3. For security and OPSec’s sake: We use the Principle of Least Privilege (PoLP) when it comes to API Keys. That means only what is needed is enabled by the client when configuring an API key.
4. Together with secure, encrypted storage of the API keys, we help keep confidential data as secure as possible.
5. Clients use our crypto market-making software to benefit from increased liquidity, enhanced price discovery, and more stable and liquid markets for their tokens.

Contact details

If you are a token project interested in our market-making services can reach us at [email protected] or via the Autowhale website.

None of the content above is financial advice and is for educational purposes only.

Find more content on algorithmic trading software, crypto market making, and market microstructure on our blog.