When trading a crypto asset, it is usually important that both the buyer and seller have a liquid market around their transaction. A liquid market means that there are plenty of people willing to buy and sell the asset at a given price. To ensure that all buyers and sellers can find each other without delay, many crypto projects employ market making for their tokens.
Market making is a trading strategy that increases liquidity for a specific asset pair by simultaneously buying and selling it. This is done on both sides of the asset pair (buying from one exchange and selling to another). It allows traders to trade more easily because it reduces the time they have to wait for their order to be executed.
Token market makers typically provide liquidity in the form of limit orders. Limit orders are trades that state a maximum price that the buyer is willing to pay and a minimum price that the seller is willing to accept for their token. The difference between the highest and lowest bid or ask prices is known as the spread. Ideally, a spread should be narrow to promote healthy trading conditions.
While a spread is important, trading volume is also an indicator of the health of a token market. A high level of trading activity indicates that the asset is attractive to investors which can lead to a price increase.
The profitability of a market maker depends on the volume of their order book and the relative pricing between the two exchanges where they operate. Hence, it is critical for a project to work with reputable market makers with extensive experience in the crypto space.
In addition to providing liquidity, crypto market making for token projects can help with enhancing the accuracy of price discovery or the process by which the market determines the fair value of an asset. This is achieved through a combination of strategies, such as hedging and adjusting the size of their positions in relation to price movements.
Some of the more common market making strategies for token projects include:
Simple Market Making
This type of market making involves continuously buying and selling a particular token at a fixed spread (the difference between the buying and selling price). This can be effective in stabilizing the token’s price, but it may not be as effective during volatile markets.
Delta Neutral Market Making
This type of market-making is more sophisticated and involves hedging the position with other derivatives that have a positive correlation to the token’s price. This helps to minimize the impact of price movements on the market-maker’s risk and profit.
The MM may even use options to align their incentives with the success of the token, such as through increased token price performance. For example, if the MM owns the option to buy the token at a pre-specified strike price, they are incentivized to keep the price above that mark and take advantage of large cross-exchange arbitrage opportunities.