Cryptocurrency exchange market makers: What to expect

How to measure a market makers‘ performance and what to expect when it comes to spreads, uptime and reporting. Part 2 in our blog series sharing the emerging standards for cryptocurrency market making

There is still hardly a standard operating procedure for cryptocurrency market makers and different firms offer different packages, pricing structures and practices. In the following post we’ll try to summarize the most common and important aspects in sizing up exchange market making services.

1) Spreads

Depending on the asset and market, the market maker should offer competitive prices. We generally separate assets into three categories:

Tier 1 — BTC, ETH and stablecoin pairs should offer a tightest spread of %0.05 -%0.1

Tier 2 — Top 15 most liquid assets — the tightest spread should be 0.1% -%0.2

Tier 3 — all the rest — the tightest spread should be 0.15%- 0.3%

These numbers can vary depending on the market, overall token’s liquidity and exchange conditions.

2) Solid slippage maintenance

The market maker should maintain the majority of the capital allocated to the activity on the order books at any given moment and as much as possible (and not withdraw when reaching the KPI).
We typically recommend not to deploy 100% of the available capital into the order books as re-balancing, renewing of orders and other needs require flexibility of funds. However, the use of capital should be optimized.

3) Capital provision

A market maker should be able to either use the exchange’s credit line or bring their own capital to deploy into the market and stand within the requirements. The capital numbers vary widely, from tens of thousands to millions of dollars in value across various assets. This capital may bear an interest cost and should be included in the overall offer by the market maker.

4) Availability (uptime)

There are two major challenges which prevent the market maker from quoting in the market 100% of the time and they are both related to risk of loss:

1. Market volatility
2. Technical issues with communicating with the exchanges, often during high market volatility

As a rule of thumb, we recommend a commitment of 70% uptime across the month. In practice, we deliver much higher numbers in normal times.

Market makers will try to avoid being on the books while the market is volatile as this adds additional risk to capital and exposure to losses. This should be allowed as the exchange doesn’t want the market maker to bear a significant loss and completely withdraw from the market but this should also be mitigated with the following:

• Allow to widen the spread in these cases
• Minimize exchange malfunction specifically in this situations
• Be ready to pay back for losses caused by possible exchange malfunction (slowness, disconnectivity etc.)

5) 24/7 monitoring, support and high responsiveness

Your market will operate 24/7 — this is 4 times the traditional markets — so you need someone watching and responding to events 24/7.

6) Accurate reporting

While it is the exchange’s responsibility, a good market making firm will be tracking its own trading activity and will be able to report on it with 100% accuracy.

7) Additional trading activity

Solid firms will be adding additional value by loading their own strategies, liquidity pools and hedging needs to the exchange. If opportunity is there, this will attract additional trading activity beyond the market making program rules . As an exchange, you should take this under consideration when evaluating trading partners.

8) Ethics and Trust

While the cryptocurrency space offers an exciting new financial landscape and freedom, it also attracts bad behaviors and players who will try to take advantage of the industry while it is still in its infancy and make a quick buck. Needless to say, we strongly recommend avoiding firms who promote unethical and destructive practices such as wash trading, price manipulation, spoofing etc. Besides the fact it is illegal, it also ruins the reputation of our industry. It is immoral and eventually leads to inferior overall performance.

How to measure a market makers performance

Value can be provided in various forms so understanding what provides the most value to an exchange isn’t so clear cut. If you have built a monitoring system for your market makers and traders, the following are a few areas which you’ll probably want to cover.

Technical

1. Capital deposited to MM accounts
2. KPI (Key Performance Indicators)
3. Spread — we recommend measuring spreads from the market maker mid as it is better if provided from a much larger liquidity pool and not the target exchange.
4. Order book size — measure of layers and capital the MM is providing within the book
5. Uptime — What orders are in the market, according to size and spreads
6. Trading volume- Partnership centric market makers will try to benefit the market beyond the KPIs. It is important to measure trading participation as well.

Non technical

1. Communication and responsiveness from the team
2. Professionalism and speed of getting things done
3. Reliability — consistent with their promises and deliverables

In the previous article we discussed how to attract the best market markets to a cryptocurrency exchange

*This article is an abridged version of a document we share with prospective clients and partners.

We hope you found this article informative and helpful, if you have any questions you are welcome to contact andrew@efrontier.io

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