Efficient Frontier
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Efficient Frontier

Creating liquidity: Attracting crypto market markets

What are the best practices for incentivizing liquidity providers to allocate recourse to a cryptocurrency exchange? Efficient Frontier shares insights from trading algorithmically 24/7/365 in over 40 cryptocurrency exchanges

Every year more cryptocurrency exchanges are founded. There’s almost no limit to the amount of work and capital a firm can put into providing liquidity to an exchange, but in practice, market makers need to decide how much additional capital, operations, and R&D resources they allocate to each venue.

Technical standards

  1. Simple integration, documentation and responsive support.
  2. Solid infrastructure: minimal bugs, latency and errors in the exchange or the API.

Smart incentive programs

  • Spread (prices)
  • Slippage (liquidity/capital)
  • Uptime (availability)
  • Trade volume KPI — Getting incentives for generating trade volume in absolute numbers (can be maker, taker or both — not wash trading)
  • Getting incentives for generating a specific percentage share of the overall exchange volume (this will typically be a bonus and not a stand alone)

Quantifiable trust

Security and responsibility over capital deployed

Technological reliability

Providing access to current and previous activity on the exchange

  1. Trading volume data
  2. Market participants (how many; is trade concentrated in the hands of a few or more evenly spread out; etc.)
  3. Order book status (slippage, spreads, consistency, level 1 and level 2 historical data)
  4. Market surveillance (against spoofing, wash trading etc.)

Trusting new exchanges

  • Security systems have a limited history in handling funds, and even then typically with limited amounts.
  • The matching engine, leverage and other risk management systems are young and behave immaturely.
  • API connectivity issues which lead to trading errors, which can cause losses

Other trust building factors

  • Compliance with regulations, KYC, and legal handling
  • Legal agreement wording and process — should be clear, fair and simple.
  • The team’s background
  • Funding status and partners/investors
  • The belief that the exchange is going to grow and be a long lasting partner
  • Ensure and be able to demonstrate the strength of your security system and process
  • Take responsibility for funds in case of loss due to system malfunction, theft or error.
  • Use third party solutions like Fireblocks and Copper to allow players to control and move funds more securely
  • Provide assets or credit lines on the exchange instead of requiring capital where possible.

In the next post we’ll share our insights on what to expect from a cryptocurrency market maker and how to measure its performance

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Sarah Wiesner

follow me on twitter @internethello @bitcoinembassy @efrontier_io