Crypto market making is essential for ensuring liquidity in both centralized (CEX) and decentralized (DEX) exchanges, improving the trading experience and making tokens more appealing to investors. This guide covers key aspects of crypto market making, its importance, and common questions.
October, 2024
Before reading the article, join Piotr, in our Wroclaw office kitchen, for an insightful discussion on crypto market making.
In this video, Piotr covers the basics of market making, why it’s crucial for token projects, and how it can benefit your project’s liquidity and stability. Learn about the importance of choosing the right market maker, cooperation models, and the positive impact of market making on liquidity and volatility reduction.
Watch now for valuable insights and examples from our projects.
The goal of market making is to improve the liquidity of financial instruments. It applies to both stock and cryptocurrency markets. Crypto market making is the provision of token liquidity on centralized (CEX) or decentralized (DEX) cryptocurrency markets, ensuring a seamless trading experience and making tokens more attractive to investors.
Let’s take a closer look at what liquidity is in crypto and why it’s crucial.
Token liquidity is a characteristic of its markets. In short, it means good trading conditions for investors and is a prerequisite to token growth in volume and price. On liquid markets, a token can be bought or sold at any time without significantly affecting its price. For investors, this means the ease of token trading with low transaction costs.
Market making benefits token markets with:
Picture: Liquid and illiquid markets on CEX and DEX platforms
This illustration shows examples of liquid and illiquid token markets on the CEX and DEX platforms.
On centralized exchanges (CEXes), liquidity constantly provided to a token order book ensures sufficient market depth, which results in increased trades. Wide spreads and no depth result in small trading volumes.
Decentralized exchanges (DEXes) operate differently from their centralized counterparts due to the presence of Automated Market Makers. While many tokens try to provide liquidity to their pools on their own, this often results in inefficient capital usage or considerable losses. Even an occasional lack of liquidity causes significant slippage for investors.
Market making does not directly impact token price; building liquid and healthy markets encourages investors to trade the token. Such market conditions, in turn, cause the whole organic demand to be fulfilled, which may result in a price increase.
Our experience allows us to claim that building healthy markets leads to volume growth in the medium and long term, organically, without shortcuts.
However, some parties use practices, called wash trading, which involves artificially increasing volumes, generated by one party by self-trading – without ensuring the depth of the market, simultaneously closing its own buy and sell orders. Executing trades using such techniques is market manipulation as it does not reflect the actual condition of the market, misleads investors, and contributes to building distrust of this asset.
* Some exchanges and token projects still fake their trading volume to quickly increase their position on the volume-based rankings on platforms like CoinMarketCap or CoinGecko. However, that short-term strategy negatively impacts the company’s reputation. Projects should avoid companies offering market-making services that commit to KPIs, such as guaranteed daily volumes (by using wash trading) or guaranteed token price growth.
Market makers in crypto are investment firms, usually proprietary trading firms (meaning they use their own capital) and less often hedge funds. They use algorithmic trading techniques to create market liquidity. They continuously quote both sides of the market to meet investors’ demand and supply. By quoting large order sizes with tight spreads, they lower the costs of transactions in digital assets for other market participants.
Crypto market makers take an active part in the market. They play a crucial role in building the value of an asset for both investors and token issuers. They are building positions to buy or sell assets, ensuring enough liquidity to enable seamless token trading at every time and place where investors want to trade. For web3 companies, this means that having a market maker, their investors will never miss an opportunity when they would like to buy a token and there are no offers on the market. In addition, market makers ensure that a substantial transaction will not cause significant price movements, keeping it stable.
First, token projects must overcome the challenges of attracting users and building a community. With the growing number of users, token projects need to provide a friendly environment for trading tokens on cryptocurrency exchanges. Market makers help unlock their development potential and attract investors to the project.
Imagine a situation where a significant transaction to buy your token cannot be completed because there are not enough people willing to sell it at that moment. Unmet demand results in lost opportunities for volume growth thus an increase in the token price. To prevent such missed opportunities, web3 companies hire market makers. With their algorithmic strategies, market makers bridge the gap, balancing token demand with supply, being in the market practically 99% of the time (metric named uptime).
Market makers play an essential role in ensuring liquidity in the crypto market. If market makers were not present, it could lead to several potential issues like:
The above problems may discourage investors from trading such an asset. Therefore, projects often allocate a small part of the treasury to facilitate liquidity for their investors and community.
Picture 1: No market maker
Picture 2: Active market maker – liquidity 24/7
Picture 3: Active market maker – spread narrowing
Let’s take a look at the market participants in the first picture (picture 1). At the time when the first participant (Mike) wants to sell the token at a price of $101 (ask price), there are no bids at his price level. Selling at a lower price would expose him to higher transaction costs. Later, the same situation occurs when the second participant (Anna) buys the token. There is no possibility of purchasing the token at the price she would agree on. If Anna’s and Mike’s offers met simultaneously, they could successfully be executed. Here we can see two elements that disrupt liquid token trading: the lack of enough market participants (asks & bids) and the time offers can meet and be executed. That’s why you need a market maker waiting in the order book with offers to keep seamless trading. Market makers manage time risk (by executing Mike’s offer and waiting a few hours for Anna to come).
The market maker provides sufficient liquidity around the clock so that 100% of transactions can be completed (picture 2.). This contributes to the token’s efficient trading and builds confidence among investors, who can easily execute their trades at the lowest possible cost.
The market maker inserts his bids/asks between the two best in the market (picture 3), in this case the bid of Anna ($101) and Mike’s offer ($99), thus narrowing the spread.
See case studies from our customers: mature token projects, middle-size blockchain companies and web3 startups.
Example chart from one of our customer’s market:
Prior to our entry into this market, price volatility reached 165%! The stabilization of prices (with a maximum volatility of 9%) was reflected in an increase in volume.
There are two main liquidity metrics that describe market makers’ work: market depth and spread. These are the main KPI’s that they commit to.
Market depth reflects the total value of orders within a certain distance from the midpoint, the price set by the two best market offers (current price). At Empirica, we focus on a ±2% depth, often referred to as the active trading zone. This metric illustrates the size of orders the market can absorb within a specific time unit without significant price movement
Spread is the percentage distance between the best bids and asks. Market makers’ actions aim to bring these offers as close together as possible. Spread is a key metric market participants use to assess investment opportunities and risk.
Crypto market-making companies contract with web3 projects for two types of cooperation: retainer and token loan with a call option. The first model is based on a monthly fee for the market-making services. The second model assumes that the token project gives market makers a loan in tokens to use for liquidity.
There are three types of companies providing market making services we encounter in crypto space: Market Maker, Liquidity Provider and “Market Faker” (the name we invented for the purpose of this article).
Table: Types of market making
The first type, Market Maker, has an ethical approach to customers, markets and investors. It uses the client’s assets for market making and usually charges a fixed fee for his services (retainer model). In return, it is committed to providing depth to the markets, maintaining tight spreads and keeping high uptime.
Liquidity Provider acts as a Market Maker, with one exception – he relies mainly on the token loan model adding its own funds (fiat) for market making.
Unfortunately, we also encounter bad market making practices. We have named those market makers who use them “Market Fakers” because their role comes down to faking volumes. It is unfair to investors, who are increasingly sensitive to this and are quickly losing confidence in tokens.
The most common roles are Market Maker and Liquidity Provider. Companies often combine features of both by offering bespoke cooperation models.
Market making strategy is an automated investment algorithm that is used to provide liquidity, by filling up the order book with buy and sell orders, so that other market participants, buyers and sellers alike, could execute their orders whenever they need to.
The market making strategies constantly quote buy and sell orders on both sides of the order book with a defined bid-ask spread. Being always present in the market creates many risks that impose many additional requirements on market making strategies that distinguish them from other strategies:
From day one of launching markets on a centralized or decentralized platform, token projects encourage their community to trade their token. To prevent low liquidity on their digital assets, they use one or more crypto market making services (the largest projects have 3 to 4 market makers).
Less liquid or illiquid assets can experience large market volatility, which increases transaction costs for investors caused by significant price movements, wide spreads and high slippage. Market makers prevent these negative effects by making token markets liquid.
The reasons to use market making:
Attracting retail investors by ensuring good trading conditions
Increasing liquidity is the most common reason to work with market makers and, in many cases, immediately increases interest in the token among the token community and boosts its organic volumes.
Attracting institutional investors by keeping deep markets
To attract larger investors, tokens must build deep markets so that their substantial transactions do not cause significant price movements.
Increasing token accessibility with new listings
Listing scams are becoming more and more common, and fraudsters’ methods are becoming increasingly sophisticated. Market makers can advise you about choosing the exchanges that best fit your goals, raise your awareness about the terms and listing costs and introduce you to verified listing teams on verified communication channels. Often a contract with a market maker, who will support initial liquidity, is a listing condition required by exchanges.
When listing on decentralized exchanges, token projects expose themselves to sniper attacks. Market makers usually have tools to protect against sniper bot attacks during the listing process.
Efficient use of token treasury for liquidity
Providing liquidity on decentralized exchanges requires actively moving concentrated liquidity, which involves commitment from the token team. The market maker ensures that liquidity follows the price, does not expose the assets to impermanent loss and makes efficient use of token treasury.
For over 50 tokens on several exchanges Empirica makes 40-60% of the turnover, quoting them 99% of the time. On exchanges for which we are the designated market maker, we are responsible for the execution of 20-30% of the exchange’s daily volume. Hundreds of millions of usd monthly volume we generate for our partners. With Empirica you can expect the increased demand for your token in your community, healthy order books and a fair price quoted with low spread regardless of market conditions.
We specialize in building liquidity for small and medium token projects, often neglected by other market making companies. During the last years, we have crafted and optimized our algorithms solely for that purpose
Unlike many other market makers in crypto, we do not demand 3-5% of your token supply for our activities and call options. We are flexible in choosing a business model that will work for you (retainer, call option, hybrid).
We extend our liquidity services by introducing projects to exchanges and helping them negotiate listing deals. Listings on well-established cryptocurrency venues might be very hard, especailly for startup cryptocurrency projects. Top-tier digital asset platforms require a proven track record of high trading volumes on other exchanges, so it is of high importance to build a proper strategy for token listings. Usually, new cryptocurrency projects first start listing their tokens on mid-size venues and building healthy growth there. More on how we help in token listings can be found here.
Access to real-time liquidity analytics for your crypto exchange or token. We set up dashboards to monitor the liquidity of your markets. Market data and trading activities are continuously recorded into a data warehouse, calculating liquidity metrics for the dashboards. You get insights into your market liquidity and the liquidity of your competition.
Our software has worked on the markets since 2012, first on the highly competitive major stock exchanges and derivatives markets, later we expanded to crypto markets. We are engineers, we have built high-frequency trading (HFT) systems and data analytics in our DNA.
We help you set up and manage the inventory for your markets.
Expertise and keen to help
“Empirica has supported our liquidity needs for the last year. Their team is responsive, reliable, and keen to help with queries as they arise. I value their expertise and continued support.”
Client-centric approach
“We’re thankful for Empirica’s support for Aleph Zero — and are very much appreciative of their client-centric approach, proactive suggestions, and high ethical standards.”
Outstanding team’s professionalism
“Empirica team’s professionalism is outstanding, they have made significant contributions to our liquidity requirements, and continue actively collaborating with us in providing valuable insights on how we can continue enhancing our platform. We are grateful to partner with them!”
Resilient to market volatility
“Bitpanda Pro, from day one, has strived to be a highly regulated and trusted crypto exchange, the Emprica team has helped us from the start and during tough times contributing strong market share and liquidity.”
We are market makers and liquidity providers on most centralized and decentralized exchanges. Starting operations in 2010 on traditional markets, our company has built and continues to develop its own algorithmic liquidity engine to this day. Since 2018, our algorithms have provided liquidity in crypto markets supporting ambitious blockchain companies and crypto exchanges.
It is not words that testify to greatness but results. Check our results by following the case studies of our clients.
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Our solution is integrated with all major and many local digital asset exchanges. Both centralized and decentralized. The list of connectors built, maintained, and updated with every change in API is growing and includes crypto exchanges like Coinbase, Binance, Kraken, Bitfinex, crypto.com, Bequant, HitBTC, Bittrex, Bitpanda, Gate.io, and many others.
Token projects partnering with Empirica impact the development team’s roadmap for the next venues we connect.
Providing liquidity is a constant process where your capital is always at risk. Therefore it is all about stability, performance, precision, and adoption to changing conditions and evolving exchanges’ APIs. To not be gamed by other market participants, you need to use market making software built on an architecture that addresses these requirements. Otherwise, you will lose to those who do. Most crypto trading bots are doing fine with simpler alpha or execution strategies. But for efficient and profitable liquidity provision, using a retail crypto market making bot may not be enough.
An Automated Market Maker is an algorithm used by decentralized exchanges that utilize so-called liquidity pools, which store tokens locked in a smart contract using LP tokens. Liquidity pools facilitate trades between these assets, and the AMM algorithm is used to derive a price of a trading pair based on order size and liquidity pool depth. In this system, traditional order books with orders from buyers and sellers are replaced by liquidity pools which are the counterparty for the trades.
Liquidity mining is a campaign that incentivizes liquidity providers with tokens. Learn the details on liquidity mining here.
A market maker makes money in two ways:
And last but not least, because of lower transactional fees, other trading algorithms they use may be even more profitable.
Many established firms focusing on market making have recently entered the cryptocurrency space. Companies like Jane Street, Virtu Financial, Jump Trading, and even Citadel Securities are among them. These are all enormous businesses with over a thousand employees each, and they all began on Wall Street in the 1990s. They are the biggest firms on Wall Street, but will they also dominate the crypto sphere? It’s not decided yet, as our industry has many impressive native crypto trading firms that used the time very well to develop competitive technology.
The market making strategies constantly quote buy and sell orders on both sides of the order book with a defined bid-ask spread. The algorithm has a few characteristics that make it different from other algos:
For those feeling hungry for some theoretical background, here is a short list of books on market making.
Order books are automated lists that organize open buy and sell orders for an asset based on their price levels. Order books aim to show open orders in different markets in real-time in a standardized way depicting the current supply and demand situation.
| Size | Bid | Ask | Size |
|---|---|---|---|
| 10 | 20000 | 20100 | 10 |
| 20 | 19950 | 20150 | 40 |
| 100 | 19900 | 20200 | 80 |
Slippage refers to the difference between the mid-market price of an asset and the price at which the trade was executed. The slippage percentage shows how much the price for a specific asset has moved during the trade. In the example above, if we will buy 50 BTC with a market order, our slippage will be 100 USD from the midpoint value (20050).
In today’s crypto space, the liquidity provision business leaves little room for the second-best in technology and infrastructure, not to mention the usage of retail market making bots. The crypto market maker must operate a predictable, reliable, low-latency trading environment to be profitable. The system needs to be as fast as the fastest traders on the venue they are providing liquidity.
Best-in-class tools are needed to provide visibility, optimization, troubleshooting, data capture, and reporting of all electronic activity related to the business of market making firm. Established liquidity providers have built their systems in-house to maximize competitive advantage. However, the cost of developing and maintaining low-latency software is considerable.
Still, about 80% of the volume in crypto is made on centralized exchanges. CEXes use a model similar to traditional venues like the New York Stock Exchange or NASDAQ. They are intermediary platforms connecting buyers and sellers, combining the role of a custodian and a broker.
Source: The Block, data by Coingecko
As traditional market makers in the stock markets, cryptocurrency market makers connect their trading systems to centralized trading venues to automatically send bid and ask orders to the limit order books.
Based on a different concept, decentralized exchanges use a deterministic pricing algorithm called an automated market maker, which utilizes pools of tokens locked in smart contracts called liquidity pools. Digital assets are usually listed on multiple exchanges. When the price of a crypto asset in the liquidity pool of a given DEX deviates from the global market price, arbitrageurs will come in and push the price back to the market price.
Market makers on DEXes provide liquidity to the liquidity pools. The protocol shares a percentage of the fees for transactions performed in the pools with a liquidity provider.
Market makers in crypto often manage the liquidity of a token asset on CEXes and DEXes simultaneously. In such cases, they maintain price parity across different venues.
Reputable crypto market making firms will promise to make the markets efficient by managing narrow spreads and deep market liquidity. The role of a token project or exchange is to take care of the marketing side to encourage their communities to trade the assets. When both sides do their duties well, digital assets will have healthy growth on the cryptocurrency platforms.
A market maker should commit to the high availability of their services. The target quoting uptime is 100%. There are obstacles to this goal, like market volatility, inventory, and connectivity issues, which make 100%-uptime not possible. A serious algorithmic liquidity provider should commit to 95%+ uptime.
As cryptocurrency exchanges trade 24/7, liquidity providers must operate around the clock. That is why fully automated market makers manage today the crypto market liquidity. Markets are continuously monitored, and traders react to alarms generated by the trading systems.
