The myth of getting rich in the crypto market exists every day. Most players come here not to double, but to turn over. In this dark forest, crypto market makers, as the top predators closest to money, are becoming increasingly mysterious.

Price manipulation, pump-and-dump, and profiteering are synonymous with crypto market makers. However, before labeling crypto market makers with these “derogatory” labels, we, especially coin projects launched in the early days, must face up to their crucial role in the crypto market.

In this context, this article will start from Web3 and explain what a market maker is and why we need a market maker, DWF events, the main operating models of crypto market makers, as well as existing risks and regulatory issues.

I hope this article will be helpful to the development of the project, we also welcome discussions and exchanges.

1. What is a market maker?

Global leading hedge fund Citadel Securities defines it this way: Market makers play a crucial role in maintaining continuous market liquidity by providing simultaneous buy and sell quotes. This creates a liquid and deep market environment where investors can trade anytime, instilling confidence in the market.

Market makers are vital in traditional financial markets. On NASDAQ, each stock has an average of about 14 market makers, with a total of approximately 260 market makers. Additionally, in less liquid markets such as bonds, commodities, and forex, most transactions are conducted through market makers.

Crypto market makers are institutions or individuals that help projects provide liquidity and buy-sell quotes on crypto exchange order books and decentralized trading pools. Their main responsibilities are to provide liquidity and market depth in one or more crypto markets and to earn profits through algorithms and strategies by exploiting market volatility and supply-demand differences.

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

2. Why Do We Need Market Makers?

The primary goal of market making is to ensure sufficient liquidity, market depth, and stable prices, thereby instilling confidence in the market and facilitating transactions. This not only lowers the entry barriers for investors but also encourages them to trade in real-time, which in turn brings more liquidity, creating a virtuous cycle and fostering an environment where investors can trade with confidence.

Crypto market makers are particularly important for early-stage coin projects (IEO) because whether it is to maintain market heat/visibility or to promote price discovery, these projects need sufficient liquidity/trading volume/market depth.

2.1 Provide 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 to operations due to huge price fluctuations.

For example, if an investor needs to buy 40 tokens immediately, they can purchase 40 tokens at a price of $100 each in a high-liquidity market (Order Book A). However, in a 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 15 tokens at $105.2, with an average price of $103.35; or 2) wait for a longer period until the tokens reach the desired price.

Liquidity is crucial for early-stage token projects, as operations in low-liquidity markets can impact investors’ trading confidence and strategies, potentially leading to the project’s “death.”

2.2 Providing Market Depth and Stabilizing Token Prices

In the crypto market, most assets have low liquidity and lack market depth, meaning even small trades can trigger significant price changes.

In the above scenario, after the investor purchases 40 tokens, the next available price in Order Book B is $105.2, indicating that a single trade caused approximately a 5% price fluctuation. This is especially true during periods of market volatility, where fewer participants can lead to significant price swings.

The large amount of liquidity provided by market makers creates a narrow bid-ask spread for the order book (Spread), narrow bid-ask spreads are usually accompanied by solid market depth, which helps stabilize currency prices and mitigate 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 role of a crypto market maker: 1) provides large amounts of liquidity; 2) provides market depth to stabilize currency prices, which ultimately helps enhance investors’ confidence in the project. After all, every investor hopes to be able to buy and sell the assets they hold in real time at the lowest transaction cost.

3. Who Are the Major Players in the Crypto Market Making?

Market making can be considered one of the top-tier businesses in the food chain, as they hold the lifeline of a project’s token post-launch. Market makers typically collaborate with exchanges, easily forming monopolies where the market liquidity is dominated by a few large market makers.

(Crypto Market Makers [2024 Updated])

In July 2023, the crypto project Worldcoin, co-founded by OpenAI’s Sam Altman, reached agreements with market makers during its official launch. They lent a total of 100 million $WLD to five market makers to provide liquidity, with the condition that the borrowed tokens must be returned within three months or be purchased at a price range of $2 to $3.12.

The five market makers include:

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

B. Amber Group, founded in 2017, is a Hong Kong-based company with a board that includes institutions familiar to Chinese investors like Fenbushi Capital. The team members are predominantly Chinese. Participants in projects include $ZKM, $MERL, $IO, etc.

C. FlowTraders, established in 2004 in the Netherlands, focuses on providing global digital liquidity for exchange-traded products (ETPs). It is one of the largest ETF trading companies in the EU and conducts cryptocurrency ETN trading business based on Bitcoin and Ethereum.

D. Auros Global, impacted by FTX, filed for bankruptcy protection in the Virgin Islands in 2023, with $20 million in assets stranded on FTX. There have been reports of a successful restructuring.

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

4. DWF Rashomon Incident

Founded in Singapore in 2022 by its Russian partner Andrei Grachev, DWF Labs is the most popular “Internet celebrity” market maker in the market recently. 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 News Revealed

On May 9, The Wall Street Journal reported that an anonymous source, claiming to be a former Binance insider, revealed that Binance investigators discovered $300 million worth of fraudulent trades by DWF Labs during 2023. A person familiar with Binance’s operations also mentioned that Binance did not previously require market makers to sign any specific agreements governing their trading activities, including any agreements to prohibit market manipulation.

This means that, to a large extent, Binance allowed market makers to trade at their discretion.

4.2 GROWTH marketing

According to a proposal document sent to potential clients in 2022, DWF Labs did not adopt a price-neutral approach. Instead, it proposed using its active trading positions to drive up token prices and create so-called “artificial trading volume” on exchanges, including Binance, to attract other traders.

In a report prepared for a token project client that year, DWF Labs even explicitly stated that the firm successfully generated artificial trading volume equivalent to two-thirds of the token’s total volume and was working to create a “believable trading pattern.” By collaborating with DWF Labs, the report suggested that the project tokens could benefit from a “bullish sentiment.”

4.3 Binance’s Response

A Binance spokesperson stated that all users on the platform must adhere to the general terms of use prohibiting market manipulation.

A week after submitting the DWF report, Binance dismissed the head of its monitoring team and, in the following months, laid off several investigators. A Binance executive attributed this to cost-cutting measures.

Binance co-founder He Yi stated that Binance has always strictly monitored market makers and that competition among market makers is intense and involves dark tactics, including PR attacks on each other.

4.4 Possible Reasons

On the Binance platform, DWF holds the highest “VIP 9” level, which means DWF contributes at least $4 billion in trading volume to Binance each month. The relationship between market makers and exchanges is symbiotic, and Binance had no reason to alienate one of its biggest clients over an internal investigator.

5. Main operating modes of crypto market makers

Like traditional market makers, crypto market makers make profits through the spread between buys and sells. They set a low buying price and a high selling price, and profit from the difference, which is often called “Spread” - the most important basis of profit for market makers.

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

5.1 Retainer + Performance Fee

In this model, the project team provides tokens and corresponding stablecoins to the market makers, who then use these assets to provide liquidity for CEX order books and DEX pools. The project team sets KPIs for the market makers according to their needs, such as acceptable price spreads, required market liquidity, and depth.

A. The project team may initially provide market makers with a fixed setup fee to start the market-making project.

B. Subsequently, the project team needs to pay the market makers a fixed monthly/quarterly subscription fee. The basic subscription fee usually starts at $2,000 per month, with higher fees depending on the scope of services, with no upper limit. For example, GSR Markets charges a $100,000 setup fee, a $20,000 monthly subscription fee, plus a $1 million BTC and ETH loan.

C. Additionally, some project teams incentivize market makers to maximize profits by paying KPI-based trading commissions (incentives for market makers who successfully achieve KPI targets).

These KPI targets may include trading volume (which may involve illegal wash trading), token price, bid-ask spread, and market depth.

In this model, the market-making approach is relatively clear and transparent, making it easier for the project team to control. It is more suitable for mature project teams that have clear goals and already established liquidity pools in various markets.

5.2 Loan/Options Model

The most widely adopted market maker model currently in the market is Token Loan + Call Option. This model is particularly suitable for early-stage token listing projects.

Due to limited funds at the initial listing stage, project teams find it difficult to pay market-making fees. Moreover, there is a limited circulation of tokens in the market during the early listing phase. Therefore, project teams lend early-stage tokens to market makers, who also assume corresponding risks.

In this scenario, it is more appropriate for market makers to set their own KPIs based on the project’s situation. To compensate market makers, project teams usually embed a Call Option in the market-making contract to hedge against token price risks.

In this model, market makers borrow tokens from the project team (Token Loan) to ensure liquidity and stable token prices in the market, typically for a term of 1-2 years.

The Call Option specifies that market makers can choose to purchase the borrowed tokens from the project team at a predetermined price (Strike Price) before the contract expires. It is important to note that this option gives market makers the right to choose, not an obligation (OPTION not Obligation).

The value of this Call Option is directly related to the token’s price, providing market makers with an incentive to increase the token’s value. Let’s take an example:

Suppose the Mfers project engages a market maker and signs a Call Option, agreeing to lend 100,000 tokens at a Strike Price of $1 with a term of 1 year. During this period, the market maker has two options at expiration: 1) return 100,000 Mfer tokens; or 2) pay $100,000 (at the $1 Strike Price).

If the token price rises 100x to $100 (Mfers to the Moon), the market maker can choose to execute the option, purchasing tokens worth $10,000,000 for $100,000, yielding a profit of 100x. If the token price falls 50% to $0.5, the market maker can choose not to execute the option ($100,000) and instead purchase 100,000 tokens at $0.5 in the market to repay the loan (worth half of the Strike Price, $50,000).

Due to the presence of Call Options, market makers may have the incentive to engage in frenzied price pumping to profit from price increases and subsequently dump tokens, as well as the motivation to engage in frenzied price crashing to purchase tokens at low prices and return them.

Therefore, in the Loan/Options Model model, project teams may need to consider market makers as trading counterparts and pay special attention to the following:

A. The strike price and the amount of token borrowing that market makers obtain, which determine their profit margins and market-making expectations.

B. Also, attention should be paid to the term of the Call Option (Loan Period), which determines the market-making space within this timeframe.

C. Termination clauses in the market-making contract, outlining risk control measures in case of emergencies. Particularly, after lending tokens to market makers, project teams may lose control over the tokens’ destinations.

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

5.3 Other business models

We can also see that many market makers have first-tier investment departments, which can better serve invested projects through investment and incubation, providing services such as fundraising, project promotion, and listing. Moreover, owning shares in invested projects also helps market makers reach potential clients (combining investment with lending?).

Similarly, in OTC (Over-the-Counter) trading, tokens are purchased at a low price from project parties/foundations, and through a series of market operations, the value of tokens is appreciated. There is more gray area here.

6. Risks and Regulations

After understanding the operating model of crypto market makers, we know that besides their positive significance in the crypto market, they not only “harvest the leeks” but also target the project parties for “harvesting.” Therefore, project parties especially need to grasp the risks of cooperating with crypto market makers and the obstacles that regulation may pose.

6.1 Regulations

In the past, regulation of market makers focused on “securities” market makers, and currently, the definition of crypto assets is not clear, resulting in a relative regulatory gap for crypto market makers and market-making activities.

Therefore, for crypto market makers, the current market environment is one where “the sky is high and the birds can fly freely”, with the cost of misconduct being extremely low. This is also why price manipulation, pumping and dumping, and “harvesting the leeks” have become synonymous with crypto market makers.

We see that regulation is continuously being standardized. For example, the SEC in the United States is clarifying the definition of Broker & Dealer through regulatory enforcement, and the introduction of the MiCA Regulation in the EU also includes regulation of market maker businesses. At the same time, compliant crypto market makers are actively applying for regulatory licenses. For example, GSR Markets has applied to the Monetary Authority of Singapore for a major payment institution license (allowing OTC and market-making services within the regulatory framework in Singapore), and Flowdesk, which completed a $50 million financing earlier this year, has also applied for regulatory licenses in France.

However, the regulation in major jurisdictions does not prevent some crypto market makers from operating offshore, as they are essentially large fund accounts within various exchanges, and most of them do not have any onshore operations.

Fortunately, due to events like the FTX incident and the continued regulation of major exchanges such as Binance and Coinbase, crypto market makers coexisting with exchanges will also be subject to the internal control compliance rules of exchanges, making the industry more standardized.

Indeed, we need regulation to regulate these unethical/illegal behaviors, but before the industry explodes, we may need the industry to embrace the bubble.

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 Risks for 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 caused by the collapse of FTX led to a comprehensive defeat of market makers, collapse of leverage, and market liquidity exhaustion, with Alameda Research being a typical representative.

B. Lack of Control Over Lending Tokens by Projects

In the token lending model, projects lack control over the tokens lent out and do not know what market makers will do with the project’s tokens, which could be anything. Therefore, when lending tokens, project parties need to imagine market makers as counterparts rather than partners and consider potential scenarios due to price impacts. Market makers can achieve various objectives by adjusting prices, such as setting a lower price for new contracts through intentional price suppression or influencing proposals anonymously through voting.

C. Unethical Behavior of Market Makers

Unethical market makers manipulate token prices, inflate trading volumes through wash trading, and engage in pumping and dumping. Many cryptocurrency projects hire market makers to use wash trading and other strategies to improve performance metrics. Wash trading involves repeatedly trading the same asset back and forth to create the illusion of trading volume. In traditional markets, this is illegal market manipulation and misleads investors about the demand for specific assets. Bitwise published a famous report in 2019 stating that 95% of trading volume on unregulated exchanges is fake. A recent study by the National Bureau of Economic Research (NBER) in December 2022 found that this figure has dropped to around 70%.

D. Projects Bearing the Blame

Due to the lack of control over the tokens lent out and the difficulty in restraining unethical behavior by market makers, or the inability to know about such behavior, projects will find it difficult to avoid blame once these actions fall under regulatory scrutiny. Therefore, project parties need to focus on contract terms or emergency measures.

7. Write at the end

After reading this article, projects can gain a clear understanding of the significant contributions made by cryptocurrency market makers in providing liquidity. They ensure efficient trade execution, enhance investor confidence, facilitate smoother market operations, stabilize token prices, and reduce trading costs.

However, by revealing the business models of cryptocurrency market makers, this article also highlights the various risks associated with collaborating with them. It underscores the importance for project parties to exercise caution when negotiating terms and executing collaborations with market makers.

Disclaimer：

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