Guide to Crypto Market Making
By Daniel Dal Bello, Director.
November 2, 2023–7 min read.
Finding the right market maker for your crypto project can be a nightmare. The different models and incentives can be difficult to understand and it’s hard to separate the best firms from the ordinary.
Our team has years of practical experience working with the biggest and best market makers in the industry.
In this article we discuss our strategies to find the right partner for your token market.
Choosing the Right Partner
There is no one service provider that suits each and every token issuer. It’s important to take a calculated approach to finding the right business to partner with. There are many details to consider that are unique to your situation.
These can include:
- Funding
- Tokenomics
- Number of markets and market pairs
- Trading volume
- Reporting requirements
- KPIs
- Legal constraints
- Service models
Technical Scope
The technical market making service scope can cover CeFi and DeFi markets. For centralized markets this is focused around spread management and order book depth as the core KPIs.
Managing risk and prices between venues (price harmony) are the responsibility of the market maker.
Some firms will assist with DEX markets, though some will not. Generally, your CEX markets will be price leaders and managing DEX pairs can be unnecessarily costly. You might opt to leave DEX markets to arbitrageurs.
Market-makers can facilitate token sales (liquidations) or purchases (buybacks). Usually billed as a percentage of volume, this can be utilized to assist with operating capital in a way that minimizes impact on the market.
Non-technical Additions
Market makers are generally well-networked teams that can bring a range of additional value to their clients.
They could have strengths in many areas such as tokenomics, exchange strategy, network value, and fundraise support.
Some firms offer various additional consulting strengths or have in-house incubation programs for early-stage clients that are not ready to open their secondary market just yet.
Their experience and track record in the industry as well as proprietary dashboards and bots for real-time monitoring all serve to differentiate offerings.
Importantly, the first major decision to make is which commericial model you will engage on.
Commercial Models
There are two prevailing service models that dominate the market today. We can refer to them simply as the retainer or loan model. It is critical to understand the differences between the models when choosing your Designated Market Maker.
Retainer
The more straightforward of the two is the retainer or subscription model. This is essentially the SaaS market making format. Fees for this model will vary and are typically based on the number of markets and token pairs in scope.
Here the market maker is engaged through an agreed monthly fee to provide a market making service. Fees normally range from $2,000 for the most basic of offerings, up to $15,000 per month depending on service scope.
The client provides blended inventory (cash and tokens) to be used for the market-making activity. Typically but not always, this inventory is custodied on the client’s accounts and trading is executed through an API connection. The amount of inventory and specific KPIs of the engagement all vary and can be negotiated with the provider.
As the client provides inventory to the market maker in a retainer engagement, the client also bears the risk. This gives the client the ultimate decision-making power regarding KPIs (e.g. How much depth in the book and what spread is acceptable).
The incentives of the retainer model are generally more aligned with the client’s goals and are more neutral in nature. The engagement scope is client-centric and focused on meeting agreed KPIs like spread percentages, order book depth, and uptime.
As the client providers inventory to the market maker in a retainer engagement, the client also bears the risk.
It is common to see profit sharing incentives built into retainer proposals as a means to align the token issuer and market-maker’s goals. This creates an additional competitive dynamic in the market which has both positive and negative attributes by design.
This model is highly transparent and flexible for the client.
Loan Model
Becoming more widespread in recent years is the more technical loan model. Here the market maker will take a loan from the client which is used to provide liquidity in the market.
No monthly fee is charged and due to the loan structure and the market maker will bear the risk. This also means that the market-maker decides the KPIs of the engagement.
It’s best practice to put KPIs into contracts following this model so that you are covered in the case that the market-maker doesn’t observe the agreed KPIs when trading.
Typically, the loans are denominated as a dollar amount of the client’s native token or as a percentage of supply. Sometimes a cash component may be included, though it is common for the market maker to use their own cash to quote the other side of the pair.
When market makers receive a loan for a newly launched asset they can control an outsized percentage of the initial market. This can lead to concerns about their influence on the market and manipulation.
Due to the structure of the agreement, if prices drop significantly, the market maker can lose their ability to provide deep liquidity.
No monthly fee is charged and due to the loan structure and the market maker will bear the risk.
This model is non-custodial as the token issuer releases custody of tokens to the market maker.
So, if you’re paying nothing then what’s in it for the market maker?
Repayment optionality.
Built into the terms of the loan is typically one or several optionality clauses. These options might have different strike prices and expiry. This design gives the market maker rights to modify the way that the loan is repayed and changes the incentive structure of the engagement. In many cases designated market making is not a profitable activity. The optionality component is a way to balance this equation so that both sides are compensated.
At the end of the loan term, typically the market maker will have the choice to exercise their options or return part or all of the loan.
Which Model is Best?
There is no simple answer because every market is different and each token issuer’s circumstances vary. This is why it’s important to understand the models in order to assess which model is best for you and your tokenomics.
Retainer services are fixed cost, client-centric, and well-aligned with your goals. Emphasis is naturally focused on the service quality. The client provides inventory and therefore dictates the KPIs of the engagement.
Loan deals offload P&L risk and are inherently less transparent. They align incentives in a competitive way with more potential upside for the market-maker. There are no ongoing fees and the client is not required to provide inventory. These deals may be favourable for legal reasons or due to restrictions on certain centralized markets.
A sensible approach is to take a holistic look at your business, token economics, and strategy to decide which model might be the best fit.
Market Maker’s Role
The purpose of a market maker’s activity is to quote both sides of a two-sided market and ultimately facilitate the best trading environment possible. Their role is to make it easy and inexpensive to transact in your market.
Market makers will place both buy and sell orders while monitoring the bid-ask spread — which can be set as KPIs of the engagement. Managing these factors leads to less volatility and more consistency in the market.
Additional scope can be added depending on the complexity of your market. Arbitrage management across different venues, execution or transactional support (for sales or purchasing), and OTC access could be included services.
Non-technical areas such as tokenomic design, exchange strategy, and fundraise support are all down to the specific firm and their strengths.
Support in Choosing a Market Maker
The market-making landscape is everchanging and difficult to navigate. You are welcome to contact us at Hillrise Group to discuss any of your market-making needs. We can help you select the right long-term partner.
Send an email to admin@hillrise.group and we will get back to you.
Hillrise Group is a blockchain-native venture capital and consulting firm supporting emerging Web3 startups.
