Introduction

This guide provides insights into how token projects and exchanges can effectively collaborate with market-makers to improve liquidity and overall market health in the cryptocurrency space. Drawing from extensive experience in high-frequency trading across various financial institutions - traditional or crypto, it offers valuable strategies for navigating the crypto market.

Bootstrapping Liquidity in New Markets

New tokens and exchanges often face significant liquidity challenges at launch. Despite strong marketing efforts and compelling use cases, these nascent markets typically exhibit:

• Shallow order books

• Excessively wide bid-ask spreads

• Frequent price jumps and discontinuities

These characteristics can lead to increased asset volatility and create barriers for traders, making it costly and risky to participate in the market. To address these issues, many new exchanges and token projects turn to professional market-makers.

The primary objective of engaging a market-maker is to catalyze liquidity growth. By providing consistent quotes and depth to the order book, market-makers help create an environment where organic trading activity can flourish. As the market matures and attracts more participants, the reliance on designated market-makers may gradually decrease. In highly successful markets, the role of the designated market-maker might eventually become redundant as natural trading activity sustains liquidity.

Communication with Market Makers

Effective communication with your market maker is crucial for maintaining a healthy trading environment. Here are key aspects to consider:

1. Regular Check-ins

• Schedule weekly or bi-weekly calls to discuss market conditions, performance metrics, and any issues.

• Use these meetings to align on strategies and adjust parameters if necessary.

2. Transparency

• Encourage open dialogue about challenges faced by either party.

• Share relevant project updates that might impact trading activity.

• Expect transparency from your market maker about their strategies and any significant changes.

3. Data Sharing

• Establish a system for sharing real-time or near-real-time data on market activities.

• Agree on a set of reports and their frequency (daily, weekly, monthly).

• Consider using shared dashboards for monitoring key metrics.

4. Crisis Management

• Define clear protocols for communication during market volatility or unexpected events.

• Establish an emergency contact system for urgent situations.

• Conduct post-mortem analyses after significant market events to improve future responses.

5. Feedback Loop

• Provide constructive feedback on the market maker's performance regularly.

• Be open to receiving feedback from the market maker on market structure or token economics.

• Use this feedback to continually refine your working relationship and market strategies.

6. Confidentiality

• Clearly define what information can be shared and what must remain confidential.

• Ensure all parties understand and respect insider trading regulations and other relevant legal constraints.

7. Relationship Management

• Assign a dedicated point of contact from your team to manage the relationship with the market maker.

• Foster a collaborative relationship rather than a purely transactional one.

Maintaining clear, consistent, and constructive communication with your market maker can significantly enhance the effectiveness of your market-making strategy and contribute to a healthier, more liquid market for your token.

Selecting Exchanges

When choosing where to list a token, consider the following factors:

1. Exchange Type:

   • Decentralized Exchanges (DEXs): Often the first listing point, but typically have lower liquidity

   • Centralized Exchanges (CEXs): Offer higher liquidity and better access to retail markets

2. Tier of Exchange:

   • Top-tier: May not charge listing fees, but often require market-makers

   • Mid-tier: May charge significant listing fees (potentially hundreds of thousands of dollars)

3. Listing Requirements: Exchanges typically look for:

   • Potential for high trading volume

   • Strong community and project traction

   • Solid fundraising history

   • Compliance with legal and regulatory standards (KYC/AML)

4. Exclusivity: Some exchanges may negotiate for exclusive listing rights

Market-Making Arrangements

For Token Projects

1. Retainer Model:

   • Project loans tokens and quote currency (e.g., USDC/USDT) to the market-maker

   • Pays a monthly fee to the market-maker

   • Market-maker returns the full loan at the end of the contract

2. Options Model:

   • Project loans tokens for trading inventory

   • Gives the market-maker a call option on the loan

   • Market-maker can choose to return either tokens or stablecoins based on a predetermined strike price

For Exchanges

1. Retainer Fees: Flat monthly payments to market-makers, often used by newer exchanges

2. Tiered Fee Structure or Rebates: Lower or negative fees for market-makers

3. Trading Credits: Rewards for meeting specific liquidity thresholds or market participation criteria

4. Token or Equity Incentives: Granting tokens or equity options to market-makers

Measuring Performance

To ensure effective market-making, monitor these key performance indicators:

1. Tightness (Spreads):

   • Primary accountability metric

   • Top-tier cryptocurrencies: 0.05% - 0.1% spread

   • Other pairs: 0.1% - 0.3% spread

   • Spreads typically widen as order book depth increases

2. Latency: Assess the speed of order placement and execution

3. Uptime: While 100% uptime is ideal, consider the impact of market volatility and technical issues

4. Slippage Management: Efficient use of provided capital for maintaining order books

5. Market Responsiveness: Ability to adjust to changing market conditions

6. Reporting: Utilize market-maker dashboards and third-party tools like Glass Markets for monitoring

During periods of high market volatility, maintaining these KPIs becomes more challenging. However, market-makers should remain responsive and continue quoting to the best of their ability.

Avoiding Market Manipulation

Be cautious of market-makers who guarantee specific trading volumes, as this is often unfeasible and may indicate unethical practices. Familiarize yourself with illegal activities such as order spoofing and wash trading, and ensure your market-maker adheres to ethical standards.

While a competent market-maker can significantly impact liquidity and market perception, remember that the fundamental quality of your project remains the core driver of long-term success.

Conclusion

Working effectively with a market maker is a crucial aspect of launching and maintaining a successful token or exchange in the cryptocurrency space. By establishing initial market liquidity, carefully selecting exchanges, structuring appropriate market-making arrangements, and diligently measuring performance, projects can create a robust foundation for their tokens to thrive.

Key takeaways include:

1. The importance of addressing the initial liquidity challenge to attract organic trading activity.

2. The need for strategic decision-making when selecting exchanges and avoiding liquidity fragmentation.

3. The various arrangements available for engaging market makers, both for token projects and exchanges.

4. The critical role of performance measurement in ensuring effective market-making.

5. The necessity of maintaining open and transparent communication with market makers.

Remember that while market makers play a vital role in creating liquidity and stability, they are not a substitute for a fundamentally sound project or exchange. The ultimate success of your venture will depend on its inherent value proposition, community engagement, and overall market dynamics.

As the cryptocurrency market continues to evolve, so too will the strategies and best practices for working with market makers. Stay informed about market trends, regulatory changes, and technological advancements to ensure your approach remains effective and compliant.

By following the guidelines outlined in this guide and maintaining a collaborative relationship with your chosen market maker, you can create a strong foundation for your token or exchange to flourish in the competitive and dynamic world of cryptocurrency trading.