Market Makers in Crypto: Retainer vs. Token Loan

Market makers first appeared in the early 19th century and have since evolved into an indispensable part of the world financial markets. With the rapid growth of the Web3 industry and cryptocurrency trading occupies a significant portion of global finance, market making has adapted to meet the needs of this new landscape. It now plays a critical role in providing liquidity, reducing volatility, and ensuring that assets can be traded efficiently.

When selecting a market maker for their projects, stakeholders often face the decision between two primary models: the retainer model and the token loan model. Each model has distinct characteristics, advantages, and drawbacks.

Retainer Model

In the retainer model, clients need to prepare a market making fund that includes both their tokens and stablecoins. In exchange for the service, market makers receive a fixed monthly fee, sometimes plus a profit-sharing component to enhance alignment and competitiveness. This model is often preferred by projects with sufficient funds and a desire for full control over market making activities.

Pros:

• Transparency and Control: Projects have clear visibility into the market maker’s activities. Regular reports and agreed-upon strategies help maintain alignment between the project’s goals and the market maker’s operations.
• No Conflict of Interest: The market maker is paid with a fixed amount and profit-sharing, reducing potential conflicts of interest.
• Operational Stability: The market maker’s incentives are aligned with providing consistent service, as the market making fund is provided by the client.

Cons:

• High Upfront Costs: The fixed monthly fees and the need to fund market making activities can be substantial, posing a financial burden, especially for smaller projects.
• Uncertain Market Impact Costs: Although the fee is fixed, the actual market impact costs can be unpredictable, making it challenging to estimate the total cost accurately.

Token Loan Model

In the token loan model, the project loans a portion of its tokens to the market maker, who in turn provides stablecoins to ensure liquidity and manage the market. This model often includes a call option allowing the market maker to purchase tokens at a strike price.

Pros:

• Lower Initial Financial Outlay: Projects avoid high upfront fees by loaning tokens instead of paying cash, making this model more accessible for projects with limited budgets.
• No Exposure to Market Volatility: The project does not need to bear the risk associated with market fluctuations since the market maker uses their own stablecoins to provide liquidity.

Cons:

• Lack of Transparency and KPIs: There may be less transparency and fewer defined KPIs, making it harder to align the project’s goals with market making activities.
• Conflict of Interest: Market makers might prioritize their own profit over the project’s best interests, potentially inducing large price volatility to benefit their positions.

Choosing the Best Model for Your Project

Both retainer and token loan models play crucial roles in cryptocurrency market-making. Projects must assess their unique circumstances to choose the best model for enhancing market presence and investor confidence.

Financial Requirements: The financial requirements of these two models are usually the top consideration for projects determining the best fit. Many projects prefer the token loan model as it is more accessible and less financially burdensome, sometimes even including investments from the market maker. However, other factors must also be considered.

Market Conditions: The current state of the market and the specific market-making needs of the project are crucial considerations. In retainer model, market makers constantly update their strategy based on the project’s needs, market conditions, community, and other factors. This dynamic approach ensures that project news and developments are reflected in the trading chart. In contrast, the token loan model often lacks communication between the market maker and the project, resulting in less responsive and adaptive strategies.

Long-Term Alignment: Ensuring the market maker aligns with the project’s long-term goals is essential. In the token loan model, contracts usually last longer than a year, making it challenging to change market makers if their services do not meet expectations. Additionally, switching to a new market maker might result in significant expenses to maintain market stability when the previous market maker offloads their tokens.

Volume and Chart Management: Projects requiring substantial trading volume support and a smooth trading chart may prefer the retainer model. Given the significant trading fees required to maintain these, market makers in the token loan model may be less inclined to spend their own USDTs, especially for projects with small market caps.

Conclusion

Choosing the right market-making model is vital for a project’s success. Both retainer and token loan models have their pros and cons, so it’s important to consider your project’s needs, budget, and long-term goals. Careful evaluation will help ensure the best future for your project in the competitive crypto market.