This is a primer on marketplace design, market microstructures, and market-making from our combined 30+ years of experience in electronic trading at Tower, Citadel, Goldman Sachs and SGX. Whether you are a trader, a project launching a token, or an academic, we hope you find this four part series useful.
Part I: Marketplace Design: General theories and background information
Part II: Crypto Marketplaces: A discussion of some of the unique features of crypto marketplaces and how they are distinctive from traditional financial exchanges
Part III: Market-Making on Crypto Marketplaces: What does market-making actually mean, and how does it work?
Part IV: How to Work with a Market-Maker: Choosing and working with the right partner
Even with brilliant marketing and the most useful of utilities, most tokens and exchanges face a cold start problem. In the beginning, with few buyers and sellers, there will generally be low depth, wide bid-ask spreads, and price discontinuities, all of which increase the volatility of the asset and make it difficult and expensive for traders to engage. This is why many new exchanges and newly listed token projects will engage a designated market-maker.
The goal of any market-making activity should be to bootstrap liquidity for an exchange or token to the point where there is sufficient interest from traders to create organic liquidity. Eventually, if a market is very successful, a designated market-maker may no longer be needed at all.
One common misperception among token projects is that it’s good to be listed on as many exchanges as possible. Actually, being listed on many venues fragments liquidity, which is especially challenging when liquidity is already low. We generally recommend to projects to list on 1-2 exchanges at a time and to build up sufficient organic liquidity before listing on new exchanges.
Similarly, for new exchanges, having too many products makes it difficult to build up sufficient liquidity on any one of them. This is why creating liquidity for options is a much more difficult problem than it is for spot markets – while there’s only one BTC, there are many BTC options with different strike prices and expiry dates.
Before the token generation event (TGE), there is the very core decision of where to list on, from CEXs to DEXs. Listing on DEX usually comes first, but there is significantly lower liquidity on DEXs.
The top-tier exchanges may not charge listing fees because they know the best tokens will earn them millions in fees, but the mid-tier exchanges may charge listing fees upwards of hundreds of thousands of dollars. However, here is much more liquidity on those exchanges, as well as other better access to retail markets. Top tier exchanges do require token projects do have a market-maker before listing. This helps with minimum liquidity and volumes. Price discovery is much more efficient on CEXs, so this actually reduces costs across the board. Therefore, most projects will begin to engage a token market-maker six-months to a month before their CEX listing.
Overall – they are looking for tokens that will generate a lot of trading interest and therefore earn the exchange trading fees.
There are number of possible arrangements for token projects who wish to engage a market-maker:
Similarly, there are a number of different models for how exchanges can choose to incentivise market-makers.
During times of market volatility, the KPI’s are harder to maintain, but market-makers should still be responsive, be able to explain selling/buying pressures, as well as continue to quote.
While market-makers can help maintain volume, it is impossible for them to guarantee volume. Beware of any market-maker who guarantees certain volumes. Market-makers are also not in the business of manipulating prices. There are also a number of highly illegal and unethical practices, like order spoofing and wash trading.
In general, token market-making is common and necessary, yet a generally misunderstood service. The quality of project is core to its success, but having a competent market-maker can impact liquidity and therefore market perception from the very start.
This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations. This post reflects the current opinions of the authors and is not made on behalf of AlphaLab Capital Group or its affiliates and does not necessarily reflect the opinions of AlphaLab Capital Group, its affiliates or individuals associated with AlphaLab Capital Group. The opinions reflected herein are subject to change without being updated.
Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations. This post reflects the current opinions of the authors and is not made on behalf of AlphaLab Capital or its affiliates and does not necessarily reflect the opinions of AlphaLab Capital, its affiliates or individuals associated with AlphaLab Capital. The opinions reflected herein are subject to change without being updated.