Do crypto market makers really "manipulate the market"?

Author: Day, Blockchain in Plain Language

In the crypto industry, the sharp fluctuations of some tokens are often shadowed by market makers, who are frequently accused by the crypto community of manipulating the market. Recently, the launch of Worldcoin, which was once very popular, was revealed to have signed agreements with market makers to lend tokens to five market makers to provide liquidity for WLD.

Today, let's take a brief look at the mysterious "market makers."

What is a Market Maker

To understand market makers, one must first grasp the concept of liquidity. If an asset can be sold quickly at full value, we can say it has good liquidity. Conversely, if an asset can only be sold at a discount or takes a long time to sell, it lacks liquidity. It describes the extent to which buyers and sellers in the market can trade relatively easily, quickly, and at low cost.

Just like the pools in DEX, when we buy on different DEXs with the same amount of funds, the quantity purchased on UNI and CRV may differ, or when selling the same quantity, the amount received may vary; this is liquidity. We should understand that the quality of a project's liquidity can directly determine its life or death. Without liquidity, the project is essentially dead. Project teams rush to list on certain top platforms (listing on certain platforms means good news) because being on these platforms means enhanced liquidity and a larger potential user base.

The market makers we are discussing today primarily serve to provide liquidity to the market. Many market manipulations are also based on liquidity.

The concept of market makers originates from the securities market, but it is equally applicable in the crypto market. Market makers play multiple important roles in the crypto market, playing a key role in the development and operation of the market.

Here are the main functions of crypto market makers:

• Providing liquidity: Market makers continuously provide buy and sell quotes, creating a high liquidity environment for market participants, facilitating quick transactions, lowering costs, and increasing participation;
• Maintaining market stability: They balance supply and demand by continuously adjusting quoting strategies and executing trades during market fluctuations, preventing drastic price swings and maintaining market stability, providing a more reliable environment;
• Promoting market development and maturity: They provide liquidity for startup projects, increasing market attractiveness and tradability, attracting more investors to participate in the market, thus promoting market development and maturity;
• Providing consulting: As important market participants, market makers accumulate rich market data and information, which are of significant reference value for clients, helping them make more informed investment decisions.

The main clients of market makers include the following categories:

• Trading platforms: Trading platforms need to provide a highly liquid market environment to attract more investors and funds to enter the platform;
• Investment institutions: Investment institutions often need to conduct large transactions in the market, thus requiring sufficient liquidity support. Market makers help investment institutions efficiently execute trading strategies and reduce costs;
• High-frequency trading firms: Market makers provide a fast transaction and low-latency environment for high-frequency participants, meeting their demand for high-speed trading;
• Individual investors: Although individual investors trade smaller volumes in the market, they can also benefit from the services of crypto market makers.

Development of Market Makers

The development of crypto market makers has gone through several stages:

Initial Stage

• When the crypto market first emerged, a lack of liquidity was a major issue. The order books of platforms were often very sparse, with large bid-ask spreads and high costs. During this stage, some individuals or small teams began to provide market-making services to improve market conditions by offering quotes and liquidity; early arbitrage also belonged to this category.

Specialization Stage

• As the crypto market developed and matured, more specialized market makers began to emerge. These market makers are usually composed of professional teams or companies with richer capital, technology, and market experience. They employ more advanced algorithms and trading systems, capable of providing higher quality liquidity and tighter bid-ask spreads.

Institutional Participation Stage

• With increasing interest from institutional investors in the crypto market, more traditional financial institutions and institutional investors began to participate in crypto market-making activities. These institutions typically have larger capital scales and more comprehensive risk management capabilities, enabling them to provide larger-scale liquidity support and bring more participants and trading volume to the market.

Innovation and Intensified Competition Stage

• As competition in the crypto market becomes increasingly fierce, market makers are also continuously innovating and improving. Some market makers have begun to experiment with new trading models and strategies, such as high-frequency trading and arbitrage, to enhance efficiency and profits. Meanwhile, ongoing technological advancements provide market makers with more tools and means, such as machine learning and big data, to optimize trading decisions and risk management.

Liquidity Incentives

• It is worth mentioning that Uniswap's innovative AMM is also a type of market maker, allowing anyone to participate in market making and earn rewards, which has led to the rapid development and continuous innovation of DeFi.

Compliance and Regulatory Strengthening Stage

• With the development of the crypto market, regulatory agencies are also continuously strengthening their oversight of crypto trading.

Overall, crypto market makers are constantly evolving to meet market demands and provide a more efficient trading environment, playing an important role throughout the entire period of the crypto market.

Profit Models of Market Makers

Like traditional market makers, crypto market makers also earn profits through the bid-ask spread. However, due to the lack of regulation in the crypto market, the cost of wrongdoing is very low, and the flow of information and initiative is mainly controlled by those at the top of the industry. The image of market makers in the crypto industry can easily be associated with "whales," making retail investors easy targets for exploitation.

1) The profit models of market makers mainly come from the following aspects (which can be openly discussed):

• Bid-ask spread: Market makers profit by simultaneously providing buy and sell quotes in the market, utilizing the bid-ask spread. They set the buy price lower and the sell price higher to gain profit from the difference. This difference is usually referred to as the "spread," which is one of the primary sources of profit for market makers;
• Transaction fees: While providing liquidity, market makers also charge fees according to the platform's regulations. These fees are the costs participants pay to the platform, and market makers, as liquidity providers, can earn a portion of these as profit;
• Arbitrage trading: Market makers typically exploit price differences between different platforms or market fluctuations to engage in arbitrage for profit. This type of arbitrage operation usually requires fast execution speeds and highly automated trading systems;
• Liquidity rewards: Some platforms or protocols offer rewards to market makers providing liquidity through liquidity incentive mechanisms, such as token rewards.

It can be seen that the sources of income for market makers mainly fall into two categories:

A. Serving project teams

B. Serving trading platforms

2) The relationship between market makers and project teams

The relationship between project teams and market makers is primarily established through the provision of liquidity services, especially when new projects are launched, requiring market makers for price management. The main roles of market makers are threefold:

A. Providing liquidity

B. Stabilizing prices to prevent project failure due to excessively high or low prices

C. Market cap management to enhance project visibility

In addition to providing liquidity, market makers also help project teams formulate token pricing strategies and assist teams in cashing out. The cooperation terms and contracts between market makers and project teams outline the rights and obligations of both parties, including reserve requirements, cooperation duration, profit sharing, and other issues. Overall, the cooperation methods and terms between project teams and market makers may vary based on specific circumstances and need to be conducted on a mutually agreed basis while adhering to relevant legal frameworks. Market makers tend to choose well-known projects to cooperate with to increase brand exposure, while project teams also prefer well-known market makers to enhance project success rates. It is important to note that many market makers, while acting as market makers, are also investment institutions, which allows them to better support investment projects.

3) The relationship between market makers and trading platforms

Liquidity is the most fundamental infrastructure for trading platforms, so platforms offer many incentives to market makers, such as fee discounts, leveraged funds, deposit and withdrawal limits, internal API channels, and institutional client account/accounting systems. These incentives aim to attract and support market makers in providing liquidity support for trading platforms.

It is important to note that different platforms may have different requirements and cooperation models for market makers. Some platforms may designate specific market makers for cooperation, and new projects must collaborate with designated market makers to be listed.

Market makers are at the top of the food chain in the crypto industry, but this does not guarantee profitability, as they also face market and liquidity risks. The chain reaction caused by the previous collapse of Luna led to the complete failure of market makers and the depletion of market liquidity. However, this is also related to the industry's lack of regulation, lack of transparency, and various issues such as misappropriation of user funds and arbitrary leverage. Alameda Research is a typical representative of this.

Mainstream Market Makers

There are many market makers in the crypto industry, but due to the significant gap between the crypto market and traditional finance, the cooperation between market makers and trading platforms can easily lead to monopolies, with market liquidity dominated by a few large market makers. Here are a few currently well-known ones (many project market makers are not publicly disclosed, so only a portion is listed):

• Jump Trading: A high-frequency trading giant established in 1999. Market-making projects: Solana ecosystem, various DEXs, LUNA, MASK, LDO, etc.;
• Wintermute Trading: A digital asset algorithm trading company founded in 2017. Market-making projects: OP, BIUR, ARB, etc.;
• DWF Labs: A global Web3 venture capital and market-making firm that suddenly entered the public eye in 2023. Market-making projects: CFX, MASK, ACH, FET, YGG, recently accused of market manipulation due to significant fluctuations in projects like YGG and DODO;
• Sigma Chain: A crypto asset trading company registered in Switzerland, with the SEC naming CZ as its actual owner in a lawsuit document against a certain entity;
• Galaxy Digital: A crypto and blockchain asset management company established in 2018;
• B2C2: A crypto financial services company founded in 2015, trading and market-making crypto assets globally;
• GSR: A crypto financial services company established in 2013, headquartered in Hong Kong;
• Amber Group: A global crypto fintech company headquartered in Hong Kong, founded in 2017.

Many project market-making services and specific details remain undisclosed, and much information is leaked through interviews with some market makers, often remaining in a "quietly making a fortune" state. After all, letting ordinary investors know who "cut" them would tarnish their reputation, so it is better to remain hidden. Just like the previous WLD market-making-related information and various details, it was still pieced together by netizens from various clues.

Conclusion

The above is related content about market makers. As key participants in the crypto market, market makers play an important role in maintaining market liquidity, improving market efficiency, and reducing costs. For investors, understanding the relevant knowledge of market makers will help them participate in the market.