Ten Questions and Answers to Clarify the Market Maker "Black Box": Why Are VCs Getting Involved in Market Making? Are Project Teams Really Vulnerable to "Backstabbing"?

Authors: flowie, Nianqing, ChainCatcher

Last week, Binance suddenly issued a directive to shut down market makers, and the conflict finally shifted from VCs and exchanges to market makers. However, for most people, market makers are like a black box, difficult to understand and often misunderstood. This article organizes some common questions and reference answers that people have regarding crypto market makers (mainly referring to market makers serving projects on CEX).

1. What are the crypto market makers?

Currently, RootData has recorded around 60 crypto market makers. However, the actual number of market participants may be far more than this, as many market makers operate anonymously behind the scenes.

Among the 60 publicly disclosed, only a few are active in the public eye, and which market makers are involved in which projects remains a black box for most ordinary users.

It is difficult to provide a simple classification or ranking of market makers, but currently, based on on-chain total holdings, the larger ones include Jump Trading, Wintermute, QCP Capital, GSR Markets, B2C2 Group, Cumberland DRW, Amber Group, DWF Labs, and Flow Traders, which are also well-known market makers in the market.

2. Which type of market maker might be manipulating the market?

From an insider's perspective, market makers are generally divided into active market makers and passive market makers. Maxxx, Head of Ecosystem at Metalpha's market maker business, provided a detailed introduction in his tweet. Recommended reading: A Confession from a Frontline Market Maker: A Dark Forest Survival Guide for Project Parties

In simple terms, active market makers are often referred to as "whales," colluding with or backstabbing project parties to manipulate market prices and harvest retail investors. Many active market makers may only come to light after being investigated and prosecuted by regulatory agencies.

Passive market makers primarily place maker orders on the order books of centralized exchanges, providing market liquidity and are more neutral, not dominating coin prices. The strategies and technologies they provide are also relatively standard.

Due to significant compliance risks, active market makers often operate anonymously.

Some active market makers may disguise themselves as investment institutions or incubators.

The market maker Web3port, which was recently reported to be banned by Binance, presented itself as an incubator and has participated in 26 investments in the past year, with at least 6 projects that have issued tokens.

The degree of profitability can also indicate whether a market maker is active or passive. According to crypto KOL @octopusycc, "profitable market-making institutions" are likely to be manipulating the market, with very few actually engaged in market making.

A healthy market-making business should provide quotes to both buyers and sellers, maintaining market liquidity and relatively stable prices. In this model, the profit margin is not large and relies on exchange incentives and other models.

3. Which crypto market makers have been sued or investigated by regulatory authorities?

After the crypto crash in 2022, crypto market makers became one of the key targets for regulatory investigations. However, after Trump took office, the regulatory environment was relaxed, and some lawsuits were gradually withdrawn or settled.

The first market maker to be closely monitored by regulators was Jump Crypto. A 2023 U.S. class action lawsuit revealed that during the 2022 Terra UST stablecoin collapse, Jump Crypto's subsidiary Tai Mo Shan Limited collaborated with Terra to manipulate the UST price, profiting nearly $1.3 billion, leading to an SEC lawsuit for market manipulation and operating as an unregistered securities dealer. However, in December 2024, Tai Mo Shan agreed to pay the SEC a settlement of $123 million and has recently been expanding its team to resume crypto operations.

In addition to the SEC's accusations, on June 20, 2024, Fortune reported that the CFTC was also investigating Jump Crypto, but no formal charges have been initiated yet. Recommended reading: “Jump's Dark History: A Comprehensive Return to Crypto Operations Faces an Awkward Situation”

Another large market maker, Cumberland DRW, was also accused by the SEC of being an unregistered securities dealer and profiting illegally through trades with investors. This lawsuit was also recently withdrawn.

Compared to these two large market makers, in October 2024, a large-scale fraud and manipulation charge against eighteen individuals and entities in the crypto market initiated by the SEC in conjunction with the FBI and DOJ brought some market makers to light, including Gotbit Consulting, ZM Quant Investment, and CLS Global. These market makers were primarily accused of being meme market makers.

In addition to regulatory accusations, the very active crypto market maker DWF Labs has been repeatedly reported by media outlets like CoinDesk and The Block for market manipulation details.

For example, The Block stated that DWF managed to collaborate with 35% of the tokens ranked in the top 1000 by market cap within its short 16-month history. One significant reason is that DWF promised potential clients "to pump" when discussing business. For instance, shortly after its establishment in September 2022, DWF's promotional materials frequently mentioned price actions. In a section titled "Price Management," DWF claimed it could synchronize with potential clients' marketing teams to help the token's price respond to relevant events, commonly referred to as "coordinating favorable price movements."

Recommended reading: “The Block Investigates DWF Labs: The Operational Secrets Behind Investing in 470 Projects”

4. What are the common manipulative behaviors of market makers?

The malfeasance of market makers usually manifests as harm to the market and harm to project parties. Common manipulative behaviors include:

1. Wash trading. Creating artificial trading activity by simultaneously buying and selling assets to increase trading volume and liquidity.

2. Fraud. Placing large buy or sell orders without the intention of executing them, aiming to mislead other traders and influence asset prices.

3. Pump and dump. These schemes involve coordinating with other market participants to artificially raise asset prices through aggressive buying. Then, the market maker sells at a higher price, causing a price crash.

There are many examples of market malfeasance. For instance, Jump Crypto was fined $123 million for collaborating with Terra to manipulate the UST price, and Alameda Research was implicated in the previous bull market collapse.

Let's look at a case of harm to project parties:

In October 2024, crypto game developer Fracture Labs sued Jump Trading, accusing Jump of implementing a "pump and dump" scheme using its DIO game token.

In the lawsuit, Fracture Labs stated that it reached an agreement with Jump in 2021 to assist in the initial issuance of its DIO token on the cryptocurrency exchange Huobi (now HTX). Fracture Labs lent Jump 10 million DIO tokens worth $500,000 and sent an additional 6 million tokens worth $300,000 to HTX. The token price subsequently soared to a high of $0.98, with Jump's borrowed tokens valued at up to $9.8 million, after which Jump sold all its holdings at the peak.

The "mass liquidation" caused DIO to plummet to $0.005, and Jump subsequently repurchased 10 million tokens at a lower price (around $53,000) and returned them to Fracture Labs, terminating the agreement.

In this incident, the cooperation model between Fracture Labs and Jump is a mainstream Token loan model. Although common, there are numerous cases where project parties have been "cut."

5. What are the cooperation models between market makers and project parties?

As mentioned earlier, market makers are divided into active and passive.

Active market makers often do not have many standards. Maxxx mentioned in his tweet that the terms of cooperation vary widely, involving borrowing tokens, API integration, margin trading, profit sharing, and other models. There are even cases where rogue market makers do not communicate with project parties and directly use their own funds to seize tokens, and after acquiring enough chips, they operate on their own.

So how do market makers operate? Canoe founder Guangwu shared common ways institutions operate tokens in his article.

One is strong whale control, where, under the condition that the project's fundamentals are sound, a target is chosen to begin operations (the project party may know or may not know, which is not significant).

• The first phase is accumulation: the typical market behavior is to continuously accumulate at low prices.
• The second phase is the consensus phase of the market maker institution. The main indicator in this phase is trading volume, where a wave is first pumped up, and then during fluctuations, the market maker exchanges hands with other market makers (recouping costs, improving capital utilization, establishing risk control models).
• The third phase is the "cutting leeks" phase. Further pumping occurs, while selling off to recoup funds, and some institutions may even assist the project party in building fundamentals during this step.

The second method is to create a value anchor for the target, quickly improving the project's fundamental quality through borrowing and derivatives. The former head of trade at FTX, @octopuuus, mentioned that under the borrowing model, collateralizing FTT to borrow BTC/ETH, the value anchor of FTT becomes BTC and ETH, with circular borrowing and leverage, and it is even possible to pump FTT with the borrowed BTC/ETH.

Recommended reading: “Whale Operation Stories: The Love-Hate Relationship Between Market Makers, Project Parties, and Exchanges”

More benign passive market maker services are relatively standardized. The service models are divided into Token loan (borrowing tokens) and monthly fee models. The Token loan model is currently the mainstream and widely adopted cooperation model. Recommended reading: “A Confession from a Frontline Market Maker: A Dark Forest Survival Guide for Project Parties”

Source: Maxxx's tweet

Under the Token Loan model, project parties need to lend a certain proportion of tokens to market makers for market making.

After the service period ends, the project party needs to return the tokens but will settle according to the agreed option value. (The option value refers to the economic value of the option contract at a specific point in time), for example, if 1 million U tokens are borrowed, and the option value accounts for 3% of the borrowed token assets, upon return, the project party can earn 30,000 U in cooperation income, which is also the main source of income for market makers.

Choosing the Token Loan model benefits project parties by quickly establishing liquidity through the market maker's expertise, avoiding the risks of operating themselves.

The monthly fee model is relatively easier to understand; project parties do not lend tokens to market makers, and market makers provide market making through API integration. Project parties do not worry about market makers doing harm, but they bear the profits and losses during the order placement process. Project parties also need to pay a monthly service fee.

6. How competitive is the market making space? Why do VCs want to build their own market making teams?

Maxxx mentioned in his tweet that not only are market makers increasingly competitive, but many VCs and project parties are also temporarily forming teams to start market making. Some teams even lack basic trading skills and just take the tokens first, as they ultimately end up at zero, not fearing the inability to cash out.

The reason is clear: as coin prices become the only product for most projects, the liquidity that unlocks at the opening is the most valuable part.

For example, although VCs obtained token shares early on, they had to wait for project parties to open and unlock step by step according to the rules, while market makers can unlock immediately at the opening, providing significant operational space.

7. Why are crypto market makers investing?

From the perspective of industry insiders, good project parties are usually surrounded by market makers. By investing, they can engage with project parties early on and can legitimately follow up on the project's progress post-investment, seizing opportunities at key projects and critical nodes in market making.

For project parties, besides receiving real cash, they also gain a sense of security by being in a shared interest community with market makers. During the token listing phase, market makers can indeed provide significant assistance. Exchanges already have some requirements for market makers regarding token listing projects.

However, this is not entirely a good thing. Even if market makers invest, they may not always act in the mutual interest of both parties.

Moreover, market makers' investments may not necessarily be genuine investments. The Block reported in its exposé on DWF that many industry insiders believe DWF's millions of dollars in investments in crypto startups are more akin to over-the-counter trading. These OTC trades allow startups to convert their tokens into stablecoins instead of DWF injecting cash upfront, and then DWF transfers the tokens to exchanges.

Some market makers' investment dynamics have become signals for ordinary investors to anticipate price pumps.

In addition to investments, crypto market makers also provide other resource support to collaborate with project parties.

For example, liquidity support; if it is a DeFi project party, market makers can promise to provide liquidity support.

And connecting resources like VCs and exchanges. For instance, introducing more VC investors and helping project parties manage relationships with exchanges. Especially in the strong buying market of South Korea, market makers can offer comprehensive liquidity planning.

8. Why do project parties often choose multiple market makers?

Knowing that eggs should not be placed in one basket, project parties choose three or four market makers to disperse the opening liquidity held by market makers, reducing the risk of malfeasance.

However, "three monks have no water to drink," this method may also carry risks. According to industry insiders, some market makers may slack off and not perform their duties, making it difficult for project parties to monitor market makers' behaviors and hold them accountable.

9. Do market makers have such a significant capacity for malfeasance?

A study by Forbes in 2022 on 157 cryptocurrency exchanges found that over half of the reported Bitcoin trading volume was fake or non-economic wash trading.

As early as 2019, a white paper submitted by Bitwise Asset Management to the SEC indicated that 95% of Bitcoin trading volume was fake or non-economic among the 83 exchanges analyzed at that time. This finding sparked widespread concern in the industry regarding market maker behaviors.

Market makers may not be the root cause, but they are indeed the primary tools for executing manipulative operations.

As service providers, market makers are often just guns, tools. The demands of exchanges and project parties are the starting point.

During bull markets, the entire system jointly creates massive profits, allowing all parties to maintain at least a minimum level of cordiality. However, in bear markets, this entire chain accelerates the liquidity crisis, leading to a repeat of face-tearing and mutual accusations.

Market makers are not entirely the "scapegoats" for liquidity exhaustion. The current predicament in the crypto market is not solely caused by market makers. Although they are direct creators of "false prosperity," the entire complete interest chain also includes project parties, VCs, KOLs, and yield farming studios.

10. Why is it difficult to restrain market makers' malfeasance?

The lack of regulation is indeed a core reason for market makers' malfeasance, but the inability of project parties, exchanges, and other trading counterparts to effectively restrain them is also an important factor.

Due to the covert nature of market makers' actions, the industry has yet to form clear and unified standards and norms. Project parties themselves also find it challenging to supervise and restrict market makers' operations. Once malfeasance occurs, project parties often have to rely on post-event accountability, but this accountability is often very weak.

According to industry insiders, besides on-chain market making, currently only centralized exchanges can monitor market makers' behaviors. Although market makers generally agree with project parties on monitoring methods, once tokens are handed over to a third party, they must rely heavily on that party's reputation and ethical standards.

Of course, project parties can also choose the monthly fee model offered by market makers. The monthly fee model usually involves short-term contracts (settled monthly), allowing project parties to flexibly adjust cooperation partners or strategies based on market performance, avoiding long-term binding with unreliable market makers. Project parties can also negotiate to include KPIs (such as minimum daily trading volume, maximum price spread limits) in the monthly fee contract to ensure the quality of market makers' services. However, the problem with this model is that project parties transfer the risks that were originally spread across market makers back onto themselves, needing to bear losses.

Additionally, while project parties can negotiate details like accountability for breaches in the contract terms, determining what constitutes a "breach" by market makers is also challenging. Project parties need to provide sufficient evidence to prove market makers' breaches, but even with trading records, proving "causal relationships" (i.e., that market makers' actions directly led to price crashes) requires extensive data analysis, which is costly and time-consuming in legal proceedings. Market makers can still argue that market fluctuations are due to external factors (such as macroeconomic events or investor panic).

The entire process involves different trading counterparts, including exchanges, project parties, and market makers, making it difficult for project parties and the market to have 100% awareness of market makers' operations.

Moreover, due to the symbiotic nature of cooperation between centralized exchanges and market makers, exchanges find it challenging to implement thorough crackdowns on their largest profit creators. Therefore, in the GPS and SHELL incidents, Binance ultimately chose to freeze the accounts of market makers involved in the GPS incident and publicly disclose detailed evidence and malfeasance methods, which is highly groundbreaking. Proactively disclosing evidence and taking action is, to some extent, a positive response to regulatory pressure and also reflects industry self-discipline. This may encourage other exchanges to follow suit, forming a new trend in the industry to protect users.