A Zoom on market makers (AMMs), key players in the crypto world

What is a Market Maker?

Definition of a Market Maker

Market makers are essential players in the financial sector, with the primary role of ensuring market liquidity. In the cryptocurrency sector, as in traditional markets, their mission is to ensure that there is always a buyer and a seller for an asset, helping to prevent sharp price fluctuations. By providing constant buy and sell orders, market makers allow traders to complete their transactions without causing significant price movements, thereby stabilizing the market.

How Does a Market Maker Work?

Market makers use algorithms to place simultaneous buy and sell orders on centralized (CEX) and decentralized (DEX) exchanges. By continually adjusting their prices based on market conditions, they capture the spread (the difference between bid and ask prices), which constitutes their profit margin.

On more advanced platforms that offer services like futures or perpetual contracts, market makers may also handle liquidations or position buybacks. This requires substantial liquidity to ensure the smooth functioning of these markets.

Their Roles in the Crypto Ecosystem

Market makers play a crucial role in facilitating cryptocurrency transactions. Here are their primary contributions:

• Increasing liquidity: By adding liquidity, market makers create an environment where traders can buy and sell cryptocurrencies without causing large price movements, thereby reducing slippage (the difference between the order price and the execution price).
• Stabilizing prices: By filling the gap between supply and demand through arbitrage, market makers help stabilize prices in crypto markets, minimizing volatility that might otherwise deter larger investors.
• Enhancing trading experience: By ensuring continuous order availability, market makers enable quick transaction execution, providing a better experience for traders who don’t have to wait for a buyer or seller for each operation.
• Additional support: Many market makers now offer supplementary services, such as network access, guidance on tokenomics, or fundraising assistance.

Who Benefits from Market Making Services?

Market making services benefit a variety of players in the crypto ecosystem, each gaining specific advantages:

• Exchanges (CEX and DEX): These platforms gain better liquidity, attracting more traders by making transactions smoother.
• Algorithmic traders and quantitative funds: Improved order execution and reduced slippage help algorithmic traders maximize profits while minimizing risk.
• Institutional investors and asset managers: For large transactions, sufficient liquidity enables entering and exiting positions without causing sharp price movements, ensuring optimal entry and exit points.
• Token projects and ICOs: New projects and emerging tokens need market makers to ensure liquidity on exchanges, bolstering investor confidence and promoting wider adoption.

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Market Making Strategies in the Crypto Ecosystem

Market making relies on advanced strategies and technological tools, which optimize profits while stabilizing cryptocurrency markets. Here are some of the most common strategies:

Placing Limit Orders

A basic strategy involves placing limit orders on both sides of the order book (buy and sell). This allows market makers to control the prices at which they’re willing to buy and sell, ensuring they avoid disadvantageous positions while generating consistent revenue.

Capturing the Spread

As discussed earlier, the main objective for market makers is to capture the spread, which is the difference between the maximum buy price a buyer is willing to pay (bid) and the minimum sell price a seller is willing to accept (ask). By balancing supply and demand, market makers complete both transactions and capture the spread, making profits without directly exposing themselves to the market.

Using Advanced Algorithms

Advanced algorithms are crucial in market-making strategies. These algorithms can process large volumes of real-time data, enabling market makers to identify the best opportunities and optimize their trading performance. This allows them to adapt quickly to changing market conditions and respond to volatility.

Real-Time Data Analysis

Real-time data analysis is vital for a market maker. By continuously monitoring market conditions, they adjust their orders to remain competitive and respond quickly to market dynamics. This flexibility is particularly important during volatility spikes, where quick adjustments can help protect against potential losses.

Arbitrage and Statistical Arbitrage

Arbitrage is one of the most widely used strategies in market making, involving taking advantage of price differences between different platforms or markets. For example, a market maker might buy an asset on one platform where the price is lower and sell it on another where it is higher. Statistical arbitrage, on the other hand, relies on complex algorithms and predictive models to identify small price deviations at high frequencies.

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Market Maker Compensation Models

Market makers employ different compensation models based on the nature of the projects, assets, and platforms involved. These models ensure economic incentives that support their commitment to stabilizing markets.

The Retainer Model

The “Retainer” model is a compensation model where a cryptocurrency project pays a market maker regularly, often monthly, to ensure consistent liquidity for a specific token. This approach functions like a subscription, where the market maker commits to maintaining active order books across multiple platforms, thereby ensuring transaction fluidity.

This model is commonly used by projects that require stable liquidity. Costs vary depending on liquidity needs, the number of markets to cover, and expected trading volumes.

The Loan + Call Option Model

The “Loan + Call Option” model is a more complex approach involving a token loan from the project to the market maker. In addition to managing liquidity, the market maker receives a call option that allows them to purchase the borrowed tokens at a predetermined strike price. This model benefits the market maker, who can earn from active token trading while controlling the risks associated with volatility.

Market makers are compensated through loan interest and profits made from the trading spread. This model is often carefully negotiated between both parties, with conditions adapted according to volatility and project goals.

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Major Players in Market Making

In the cryptocurrency sector, several key players dominate the market-making space. Through sophisticated strategies, advanced algorithms, and global exchange networks, these companies bring essential stability and depth to the crypto market. Here are the main players:

GSR

• Social Networks: @GSR_io
• 60+ exchanges (CEX + DEX)
• Licenses in 8 US states, Singapore
• Investments in Coinlist, dYdX, Ethereum, The Graph, Safe, Kiln, Reserve...

Cumberland

• Social Networks: @CumberlandSays
• 30+ years trading experience with parent company DRW
• Chicago, Singapore, London
• Support for institutional investors (Goldman Sachs)

Flowdesk

• Social networks: @flowdesk_co
• 140+ exchanges (CEX + DEX)
• Stamford, Singapore, Paris, Toronto
• 9+ layers 1 and 2 supported
• 400+ cryptocurrencies

DWF Labs

• Social Networks: @DWFLabs
• 60+ exchanges (DEX + CEX)
• Followed by @lookonchain for investment volatility
• Investments in 250+ projects

Wintermute

• Social networks: @wintermute_t
• 4,000 billion cumulative trading volume
• UK, Singapore
• 50+ exchanges (CEX + DEX)

Kairon Labs

• Social Networks: @KaironLabs
• 100+ exchanges
• 200 billion trading volume
• Customized algorithmic strategies

Galaxy Digital

• Social Networks: @galaxyhq
• 7.8 billion AUM
• 1000+ institutional partners
• Strong presence in North America, Europe and Asia

Keyrock

• Social Networks : @KeyrockTrading
• 85+ exchanges (CEX + DEX)
• Brussels, London
• Algorithmic beta created in 2017

Other notable players include Jump, Jane Street, Flow Trader, and GotBit (mentioned by @zachxbt).

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Conclusion: Market Makers, Pillars of Crypto Liquidity

Market makers play a crucial role in decentralized finance, ensuring stable liquidity and reducing volatility on DEXs. Through sophisticated strategies, predictive algorithms, and technical expertise, they help protocols attract users and support the smooth launch of new cryptocurrencies.

Although market makers bring many advantages, they also face challenges, such as liquidity fragmentation, which complicates the strategies discussed above.

As the crypto ecosystem continues to evolve, market makers are also innovating. Notable advances are being made in the area of “Maximal Extractable Value” (MEV), a potentially new revenue source that has been controversial among DeFi users and protocols.