The allure of quick wealth in the crypto market is a daily occurrence. Most participants come here not merely to double their investments but to transform their fortunes. In this complex and often opaque environment, crypto market makers, as key players with privileged access to capital, remain enigmatic.

Terms like price manipulation, pump-and-dump schemes, and exploiting inexperienced investors are often associated with crypto market makers. However, before casting these “negative” labels, it is essential to acknowledge the critical role they play in the crypto market, especially for early-stage token listings.

In this context, this article will provide insights from the perspective of Web3 project teams, explaining what market makers are, why they are needed, the DWF incident, the primary operating mechanisms of crypto market makers, and the inherent risks and regulatory challenges.

I hope this article will aid in project development and encourage further discussion and exchange of ideas.

1. What is a Market Maker?

Citadel Securities, the world’s leading hedge fund, defines it this way: Market makers play a vital role in maintaining continued market liquidity. They achieve this by simultaneously providing buy and sell quotes, thereby creating a market with liquidity, market depth, and the ability to A market environment that allows investors to trade at any time, which injects confidence into the market.

Market makers are crucial in traditional financial markets. On Nasdaq, there are an average of about 14 market makers per stock, for a total of about 260 market makers on the market. Additionally, in markets that are less liquid than stocks, such as bond, commodity, and foreign exchange markets, most trading occurs through market makers.

Crypto market makers refer to institutions or individuals that help projects provide liquidity and buy and sell quotes in crypto exchange order books and decentralized trading pools. Their main responsibility is to provide liquidity and trading for transactions in one or more crypto markets. Market depth and profit from market fluctuations and supply and demand differences through algorithms and strategies.

Crypto market makers can not only reduce transaction costs and improve transaction efficiency, but also promote the development and promotion of new projects.

2. Why Do We Need Market Makers?

The main goal of market making is to ensure that the market has sufficient liquidity, market depth, and stable prices, in order to inject confidence into the market and facilitate the completion of transactions. This will not only lower the entry barrier for investors, but also incentivize them to trade in real time, which in turn brings more liquidity, forming a virtuous cycle and promoting an environment where investors can trade with confidence.

Crypto market makers are particularly important for early-stage coin listing projects (IEOs) because these projects need to have sufficient liquidity/trading volume/market depth, whether to maintain market popularity/awareness or to facilitate price discovery.

2.1 Providing liquidity

Liquidity refers to the degree to which an asset can be liquidated quickly without wear and tear, describing the extent to which buyers and sellers in the market can buy and sell relatively easily, quickly, and at low cost. Highly liquid markets reduce the costs of any particular transaction, facilitating the formation of transactions without causing significant price fluctuations.

Essentially, market makers facilitate investors to buy and sell tokens faster, in larger quantities, and more easily at any given time by providing high liquidity without disruption and disruption to operations due to huge price fluctuations.

For example, if an investor needs to buy 40 tokens immediately, he can buy 40 tokens immediately at a unit price of $100 in the highly liquid market (Order Book A). However, in the low-liquidity market (Order Book B), they have two options: 1) Buy 10 tokens at $101.2, 5 tokens at $102.6, 10 tokens at $103.1, and Buy 15 coins for $105.2 at an average price of $103.35; or 2) wait for a longer period of time for the coins to reach the desired price.

Liquidity is crucial for early-stage currency listing projects. Operations in low-liquidity markets will have an impact on investors’ trading confidence and trading strategies, and may also indirectly cause the “death” of the project.

2.2 Enhancing Market Depth and Stabilizing Prices

In the crypto market, most assets suffer from low liquidity and insufficient market depth, meaning that even small transactions can trigger substantial price fluctuations.

For instance, after an investor purchases 40 tokens, the next available price in order book B might rise to $105.2, indicating a price movement of about 5% due to a single transaction. This issue is particularly pronounced during periods of market volatility, where limited participation can result in significant price swings.

The large amount of liquidity provided by market makers creates a narrow bid-ask spread (Spread) for the order book. A narrow bid-ask spread is usually accompanied by solid market depth, which helps stabilize currency prices and alleviate price fluctuations.

Market depth refers to the number of buy and sell orders available at different price levels in the order book at a given moment. Market depth also measures an asset’s ability to absorb large orders without major price movements.

Market makers play a key role in the market by providing liquidity to bridge this supply and demand gap. Just think about which of the following markets would you like to trade?

The roles of crypto market makers: 1) provide a large amount of liquidity; 2) provide market depth to stabilize currency prices, which ultimately helps to enhance investors’ confidence in the project. After all, every investor hopes to be able to trade at the lowest cost Buy and sell their holdings in real time.

3. Who are the major players in crypto market makers?

The market maker business can also be said to be one of the businesses at the top of the food chain, because they control the lifeblood of the project token after it is launched. Market makers usually cooperate with exchanges, which can easily form a monopoly, with market liquidity dominated by a few large market makers.

（Crypto Market Makers [2024 Updated]）

In July 2023, Worldcoin, a crypto project co-founded by Sam Altman of OpenAI, entered into an agreement with market makers upon its official launch. They lent a total of 100 million $WLD tokens to five market makers to ensure liquidity, with the stipulation that these tokens be returned within three months or purchased at prices between $2 and $3.12.

The five market makers are:

A. Wintermute, a UK-registered company, known for investments in $WLD, $OP, $PYTH, $DYDX, $ENA, and $CFG. Since 2020, Wintermute has invested in over 100 projects.

B. Amber Group, established in 2017, is a Hong Kong-based company with a board comprising institutions familiar to Chinese investors, such as Distributed Capital. The team is predominantly composed of Chinese members. Their projects include $ZKM, $MERL, and $IO.

C. FlowTraders, founded in the Netherlands in 2004, is a global liquidity provider for exchange-traded products (ETP) and one of the EU’s largest ETF trading companies. They have created exchange-traded notes (ETNs) based on Bitcoin and Ethereum and engage in cryptocurrency ETN trading.

D. Auros Global, impacted by FTX, filed for bankruptcy protection in the Virgin Islands in 2023 with $20 million in assets stuck on FTX. Reports suggest a successful restructuring.

E. GSR Markets, established in the UK in 2013, is a global crypto market maker specializing in providing liquidity, risk management strategies, programmatic execution, and structured products for sophisticated global investors in the digital asset industry.

4. DWF Rashomon Effect

DWF Labs is the most popular “Internet celebrity” market maker in the market recently. DWF was founded in Singapore in 2022 by its Russian partner Andrei Grachev. According to reports, the company now claims to have invested in 470 projects in total and has worked with projects that account for approximately 35% of the top 1,000 coins by market capitalization in its short 16-month history.

（Binance Pledged to Thwart Suspicious Trading—Until It Involved a Lamborghini-Loving High Roller）

Let’s review this event:

4.1 Breaking the news

The Wall Street Journal broke the news on May 9 that an anonymous source claiming to be a former Binance insider said that Binance investigators discovered $300 million worth of fake transactions in DWF Labs during 2023. A person familiar with Binance’s operations also said that Binance has not previously required market makers to sign any specific agreement to manage their transactions (including any specific agreement to regulate their trading behaviors such as prohibiting market manipulation).

This means that, for the most part, Binance allows market makers to trade however they wish.

4.2 Marketing of DWF

According to a proposal document sent to potential clients in 2022, DWF Labs did not adopt price neutrality rules and instead proposed to use its active trading positions to drive up the price of the token and sell it on exchanges including Binance. Create so-called “artificial trading volume” to attract other traders.

In a report prepared for a token project client that year, DWF Labs even wrote directly that the institution had successfully generated two-thirds of the token’s manual trading volume and was working to create a “credible “Believable Trading Pattern”, if cooperated with DWF Labs, can bring “Bullish Sentiment” to the project token.

4.3 Binance’s response

A Binance spokesperson said in this regard that all users on the platform must abide by the general terms of use prohibiting market manipulation.

A week after the DWF report was filed, Binance fired the head of its monitoring team and laid off several investigators over the following months, a move a Binance executive attributed to cost-saving measures. measure.

He Yi, co-founder of Binance, said: Binance has been conducting market monitoring on market makers and is very strict; there is competition among market makers, and their methods are very dark, and they will attack each other through PR.

4.4 Possible reasons

On the Binance platform, DWF is the highest “VIP 9” level, which means that DWF contributes at least $4 billion in transaction volume to Binance every month. Market makers and exchanges have a symbiotic relationship, and Binance has no reason to offend one of its largest customers for the sake of an internal investigator.

5. Main operating modes of crypto market makers

Similar to traditional market makers, crypto market makers generate profits through the spread between buying and selling prices. They set lower purchase prices and higher selling prices, capturing the difference as profit. This spread is the fundamental source of revenue for market makers.

After understanding this foundation, let’s look at the two main business models of market makers for project parties.

5.1 Subscription Service + Transaction Commission (Retainer + Performance Fee)

Under this model, the project party provides tokens and corresponding stablecoins to market makers, and market makers use these assets to provide liquidity for the CEX order book and DEX pool. The project party sets KPIs for market makers based on their own needs, such as how much price spread is acceptable, how much market liquidity and depth (Depth) need to be guaranteed, etc.

A. The project party may first give the market maker a fixed Setup Fees as the start of the market making project.

B. The project party will then need to pay a fixed monthly/quarterly subscription service fee to the market maker. The most basic subscription service fee usually starts at $2,000 per month, depending on the scope of services, and there is no cap. GSR Markets, for example, charges a $100,000 setup fee, a $20,000 monthly subscription fee, plus $1 million in BTC and ETH loans.

C. Of course, in order to motivate market makers to maximize profits, some project parties will also pay KPI-based transaction commission fees (the incentives obtained by market makers when they successfully complete KPI targets in the market).

These KPI indicators may include: trading volume (which may involve illegal Wash Trading), token price, bid-ask spread (Spread), market depth, etc.

Under this model, the market making ideas are clearer and more transparent, and it is easier for project parties to control. It is more suitable for mature project parties that have built liquidity pools in various markets and have clear goals.

5.2 Token borrowing + call options (Loan/Options Model)

One of the most common models for market makers today is the Token Loan + Call Option model, which is particularly beneficial for early-stage token listing projects.

Early-stage projects often face financial constraints, making it challenging to afford market-making fees. Additionally, there are typically fewer tokens in circulation during the initial phase. In this model, early-stage tokens are lent to market makers, who assume the associated risks.

Under these circumstances, it is more appropriate for market makers to set their own KPIs based on the project’s specifics. To compensate market makers for their risk, project teams typically include a call option in the market-making contract. This option helps market makers hedge against token price risks.

Under this model, the market maker will borrow tokens (Token Loan) from the project party and put them into the market to ensure liquidity and stabilize the currency price. Generally, the market making period is agreed to be 1-2 years.

The call option stipulates that before the expiration date of the contract, the market maker can choose to purchase the previously borrowed tokens from the project party at a predetermined price (Strike Price). It should be noted that this option is a right of choice given to the market maker, not an obligation (OPTION not Obligation).

The value of this call option is directly related to the price of the token, giving market makers an incentive to increase the value of the token. Let’s simulate a scenario:

We assume that the Mfers project has found a market maker and signed a Call Option, agreeing to lend 100,000 tokens with an exercise price of $1 and a term of 1 year. Then during this period, the market maker has two choices: 1) repay 100,000 Mfer tokens at maturity; or 2) pay $100,000 at maturity (based on the exercise price of $1).

If the token price rises 100x to $100 (yes, Mfers to the Moon), the market maker can choose to exercise the option, that is, buy $10,000,000 worth of tokens for $100,000, earning 100x the profit; if the token price If the price falls by 50% to $0.5, the market maker can choose not to exercise the option ($100,000), but directly purchase 100,000 tokens in the market at a price of $0.5 to repay the loan (the value is half the exercise value of $50,000).

Because of the existence of call options, market makers will have the motive to crazily pull the market and increase shipments to make profits; at the same time, there will also be the motive to crazily sell the market and purchase goods at low prices to repay currency.

Therefore, in the Token Borrowing + Call Option (Loan/Options Model) model, the project party may need to treat the market maker as a counterparty, and special attention needs to be paid to:

A. The exercise price that the market maker gets and the amount of token borrowing determine the profit margin of the market maker and the expectations of market making;

B. Also pay attention to the term of the call option (Loan Period), which determines the market-making space in this time dimension;

C. Termination clauses of market making contracts and risk control methods in case of emergencies. Especially after the project party borrows the tokens to the market maker, it has no control over the destination of the tokens.

（Paperclip Partners, Founder’s Field Guide to Token MarketMaking）

5.3 Other business models

We can also see that many market makers have primary investment departments that can better serve invested projects through investment and incubation, provide projects with services such as fund raising, project publicity, and currency listing, and have a share of the invested projects. It also helps market makers reach potential customers (investment and loan linkage?).

The same goes for OTC OTC transactions, which purchase tokens at low prices from project parties/foundations and increase the value of the tokens through a series of market-making operations. There’s more gray space here.

6. Risks and Supervision

After understanding the operating model of crypto market makers, we know that apart from the positive significance of market makers in the crypto market, they are not only cutting leeks, but project parties are also the targets of their “cutting leeks” . Therefore, project parties especially need to grasp the risks of cooperating with crypto market makers and the obstacles that may be caused by supervision.

6.1 Supervision

In the past, the supervision of market makers focused on “securities” market makers, and the current definition of crypto-assets has not been clear, which has resulted in a relative regulatory gap for crypto market makers and market-making activities.

Thus, for crypto market makers, the current market environment offers boundless opportunities with minimal consequences for unethical behavior. This low cost of misconduct is why terms like price manipulation, pump-and-dump schemes, and exploiting inexperienced investors are often associated with crypto market makers.

Regulatory efforts are continuously evolving. For instance, the U.S. SEC is clarifying the definitions of Brokers & Dealers through enforcement actions, and the EU’s MiCA legislation is bringing market maker operations under regulation. Additionally, some compliant crypto market makers are actively seeking regulatory licenses. GSR Markets, for example, has applied for a Major Payment Institution license from the Monetary Authority of Singapore, allowing them to provide OTC and market-making services within Singapore’s regulatory framework. Similarly, Flowdesk, which secured $50 million in funding earlier this year, has obtained a regulatory license in France.

However, regulation in major jurisdictions does not prevent some crypto market makers from operating offshore, as they primarily function as large capital accounts within various exchanges and often lack onshore business.

Fortunately, due to the FTX incident and the continuous regulation of major exchanges like Binance and Coinbase, crypto market makers operating within these exchanges will also be subject to the exchanges’ internal compliance rules, leading to a more regulated industry.

While we certainly need regulatory measures to curb unethical and illegal behaviors, it might also be necessary for the industry to embrace the bubble before it truly explodes.

6.2 Risks

With a lack of regulation, crypto market makers have incentives to engage in unethical trading and manipulate markets to maximize profits, rather than having an incentive to create a healthy market or trading environment. This is why they are notorious and come with many risks.

A. Market risk of market makers

Market makers also face market risks and liquidity risks, especially in extreme market conditions. The previous collapse of Terra Luna and the chain reaction of the collapse of FTX led to the complete collapse of market makers, the collapse of leverage and the depletion of market liquidity, of which Alameda Research is a typical representative.

B. The project party lacks control over lending tokens

In the token borrowing model, the project side lacks control over the loaned tokens and does not know what the market maker will do with the project side’s tokens. It could be anything.

Therefore, when lending tokens, project parties need to imagine market makers as counterparties rather than partners to conceive of possible situations that may arise due to price effects. Market makers can achieve many purposes by adjusting prices. For example, they may deliberately lower prices to set a lower price for new contracts; they may also use anonymous voting to pass favorable proposals, etc.

C. Unethical conduct by market makers

Unscrupulous market makers will manipulate token prices, inflate trading volumes through wash trades, and engage in pump and dump operations.

Many cryptocurrency projects hire market makers to improve performance metrics using strategies such as wash trading, where an entity repeatedly trades the same asset back and forth to create the illusion of trading volume. In traditional markets, this is illegal market manipulation, misleading investors about demand for a particular asset.

Bitwise famously published a report in 2019 claiming that 95% of trading volume on unregulated exchanges was fake. A recent study from the National Bureau of Economic Research (NBER) in December 2022 found that this number has dropped to about 70%.

D. The project party taking the blame

Since the project party lacks control over the lending of tokens, and it is difficult to restrain the unethical behavior of market makers, or there is no way to know about these unethical behaviors, once these behaviors fall into the scope of supervision, the project party that actually operates the project will be unable to avoid it. blame. Therefore, the project party needs to work hard on contract terms or emergency measures.

7. Conclusion

This article aims to assist project teams in recognizing the significant contributions of crypto market makers. By providing liquidity, they ensure efficient trade execution, boost investor confidence, facilitate smoother market operations, stabilize token prices, and reduce transaction costs.

However, it also sheds light on the business models of crypto market makers, highlighting the numerous risks that come with such collaborations. Therefore, project teams must be particularly cautious when negotiating terms and implementing partnerships with market makers.

Disclaimer：

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