Original source: DODO Research
Original source: DODO Research
Original editor: Daidai
FTX exploded, the empire collapsed, a series of leading platforms were hit hard, and market makers and lending became the hardest hit areas: Alameda, as one of the largest market makers in the cryptocurrency industry, was destroyed in this farce and officially launched on November 10. Closing the transaction; Genesis, a market maker and lending company under DCG, is also facing the dilemma of insufficient solvency.
The top market maker collapsed, a large amount of principal was destroyed, and the sharp unilateral market... This caused unprecedented panic among market makers in the industry. In the aftershocks, market makers tended to shut down, and the community and projects faced huge stress tests. The encryption industry market liquidity has plummeted.
Regardless of the traditional market or the encrypted market, for mass investors, talking about market makers is always like playing a game of blind men and elephants.
Table of contents
Table of contents
01. Market makers in the encryption field
- What is a market maker, how to make a market, and how to make a profit
- Market makers in crypto markets
- What is the use of a market maker
- Market making strategy
- Chance, Risk and the Wild West
02. Yes or No: Everyone is a market maker
- Market Makers and Automated Market Makers
- AMM: Everyone is a market maker
- Why LP loses money
03 The top market maker collapsed: after the market lost liquidity
- Market Maker in Dominoes
- After the market becomes illiquid
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0 1 .
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What is a market maker, how to make a market, and how to make a profit
Wikipedia explains that a market maker is called a "specialist" in the New York Stock Exchange, a "banker" in the Hong Kong stock market, and a "market maker" in Taiwan.
As the name suggests, a market maker is someone who creates a "market."
In traditional financial markets, a market maker is a commercial organization, usually a brokerage firm, large bank or other institution, whose main job is to create liquidity in the market by buying and selling securities.
Market making is an established and mature financial practice. In this process, market makers provide liquidity and depth for the market. Buyers and sellers do not need to wait for a counterparty to appear, as long as a market maker comes forward to undertake the counterparty. A deal is struck, and the market maker makes a profit by earning the bid-ask spread from both parties. The difference between the buying price and the selling price in the market mentioned here is the Bid-Ask Spread (Bid-Ask Spread). Market makers pay to increase trading volume and increase profits).
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Buying this asset requires 103, selling this asset gets 97, and the market maker gets a spread of 6
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Market Makers in Crypto Markets
No matter in the traditional market or the encrypted market, liquidity is the lifeline of all trading markets, and market makers are at the helm. In the encrypted market, market makers are also called liquidity providers (LP), which may directly point out:Like traditional markets, crypto markets need market makers to address liquidity traps by helping guide the “invisible hand” of the market.
This liquidity trap is mainly reflected in a vicious circle: crypto projects need people (cryptocurrency exchanges and crypto investors) to contribute to token liquidity; at the same time, only when the token has market liquidity, these people will participate . And this is where Market Maker comes in.
Simply put,Market Maker Liquidity Breeds Liquidityimage description
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source：Wintermute
What is the use of a market maker
Take cryptocurrencies as an example. One of the core points, of course, is the repeatedly mentioned liquidity. Because liquidity is the foundation of any efficient market.
Powerful Pricing Features:Market makers can track price changes for a long time, make judgments on market fair prices, and provide the most referenced quotations. For example, platforms like 1inch not only direct funds to different fund pools, but also ask some market makers (such as Wintermute) to quote.
Enhance market liquidity:Investors can trade directly with market makers without waiting or finding a counterparty. Market making is the provision of bilateral quotes to any given market, and this is at the heart of providing liquidity.
Improve the overall efficiency of the market:Market makers quote prices through various trading platforms and eliminate market confusion through arbitrage, which helps to improve the overall efficiency of the market. For example, Kairon Labs is currently connected to the APIs of more than 120 exchanges to help reduce the impact of price fluctuations.
Facilitate the promotion of new tokens and reduce issuance costs:Market makers will drive rising trading volumes and a flood of new tokens appearing on multiple cryptocurrency exchanges.
Increased volume and market expectations:Attract investors' attention, enhance market confidence, and promote the price of tokens
Facilitate the closing of large deals:secondary title
market making strategy
A market-making strategy refers to a strategy that establishes limit buy and sell orders separately, uses the fluctuation of the target price to trigger the limit price order, and obtains trading income through the price difference between the buy and sell orders. This is a risk-neutral spread arbitrage strategy in high-frequency trading strategies. Simply put, it is the middleman mentioned above who earns the difference.
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https://twitter.com/0 xUnicorn/status/1592007930328776706
At its core, what a market-making strategy focuses on isThe quantity of limit orders and the setting of the distance between the bid and order quotes and the middle price,secondary title
Risk, Chance and the Wild West
As mentioned above, the risk mainly comes frominventory risk。
When a large amount of inventory is accumulated in the hands, it also means that the market maker is more likely to be unable to find a buyer for its inventory, which leads to a risk:Holding more assets at the wrong time (often during a depreciation).In another scenario, market makers have to start selling inventory at a loss to stay afloat when asset prices rise.
In DeFi, the risk of market making may be handled more cautiously. For example, perpetual contracts. Market makers often use the funding rate of the perpetual contract (the core of the mechanism is to make the contract price anchor to the spot price) for spot and leveraged arbitrage. One sentence summarizes this arbitrage method: create a position with the same position value and opposite position direction in the spot/leveraged and perpetual contract markets respectively.Therefore, under abnormal price fluctuations, market makers will face a great risk of liquidation, because they may hold large positions due to arbitrage of different funding rates.
Opportunity comes from high returns behind high risks. Even with a spread of $0.01, when such a trade order is executed a million times in a day, the profit will reach $10,000. Market makers also provide traders with leverage. Once a client liquidates their positions, the market maker will be able to liquidate the trader's margin. According to coinglass data, the amount of cryptocurrency liquidation is 100-1000000000 US dollars every day. This will lead to huge profits for market makers.
It is undeniable that the encryption market is still in its early stages. Compared with the very mature market-making operations in the traditional financial market, there is still a crazy side here. If we zoom in and look at some details of crypto trading: asset liquidity is relatively low; significant slippage risk; flash crashes are very likely when large orders appear or when a large number of sell orders cancel the best bid in the order book . These characteristics often also bring some hidden corners, or benefits, to crypto market making.
Overall, due to technical and regulatory factors, market makers, the encryption market and users are still full of chaotic feelings.
Come to the Wild West. When a market maker promises a token issuer a specific volume level, the next step would be an even more ambitious promise: that the token price will rise to a specific level. How to do it?
Wash Trading (wash trading):Junior players would place a large sell order, and within seconds place another buy order of their own. A high-level player will use smaller orders, place them for a longer period of time, and operate from multiple accounts instead of one to avoid exchange detection.
Pump-and-dump:Of all price manipulation strategies, pump and sellpractice is particularly common. Social networks are the best frontrunners, and once there is enough fomo sentiment, a large number of tokens bought in advance can be sold for a profit.
Ramping:Snap buying refers to creating the impression of a big buyer. Market makers can use this strategy to create a "big buyer" who trades large amounts for a fixed period of time, and here again the fomo sentiment comes in handy as other traders race to get ahead of the "big buyer" ( But end up being a loser) — when the market takes notice of such behavior, the price naturally rises. Of course, once the market maker’s activities are over, the ghost buyer will disappear mysteriously, and the token price will likely usher in a sharp drop.
Cornering:When there are multiple market makers for a token at the same time, one market maker can make money by trying to buy most of the available tokens, forcing other market makers to increase their prices because they have to keep the spread at the same level.
Due to the complete lack of regulation, these speculative operations do appear in the execution strategies of market makers, and they end upfirst level title
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Market Makers and Automated Market Makers
While market makers (MMs) and automated market makers (AMMs) sound similar, they are completely different entities.
As mentioned earlier, in traditional finance, a market maker is an institution or platform that proposes various securities trading transactions to multiple exchanges, provides liquidity for the market, and makes profits through the difference between buying and selling.
AMM is a decentralized exchange (DEX) protocol. Unlike traditional exchanges using order books, assets are priced according to a specific pricing algorithm, and the pricing formula varies with different protocols. For example, Uniswap uses the following mathematical curve to determine transaction prices: x * y = k. where x and y are the quantities of two assets in the liquidity pool, y is the quantity of the other asset, and k is a fixed constant meaning that the total liquidity of the pool must remain constant.
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AMM: Everyone is a market maker
In the terminology of traditional finance, AMM refers to an algorithm that simulates the behavior of human market makers. In the field of DeFi, it has gradually evolved into a violent engine:
It uses an automated algorithm to balance the supply and demand of tokens in the trading pool, avoiding the situation where a certain token is short-sold (the market has no buyers/sellers pending orders) and cannot be traded due to unilateral market conditions in the order book mode; and other Market makers are different. For example, CEX market makers use bid-ask spreads. They will adjust positions to control inventory to make profits according to their own strategies. DEX market makers provide liquidity in a different way from CEX. DEX market makers also It will earn handling fees; when this part of transaction fees is given to liquidity providers, it will motivate them to inject idle assets into the trading pool to provide liquidity, and to a certain extent solve the problem of insufficient trading depth in the order book mode.
AMM-based DEX has proven to be one of the most influential DeFi innovations. It is the emergence of AMM that breaks the restrictions on order books and matching, helping DEX to break CEX's monopoly on the cryptocurrency trading market, and allowing open and free on-chain transactions became a reality. It is also AMM, which allows ordinary users to participate in market making in a permissionless way, so that every DEX can shout a proud slogan: Everyone is a market maker.
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Why LPs lose money
Now let's look at vision and reality.
The first question is, if a user becomes an LP, will it be profitable to make a market on DEX? (A voice: Have you forgotten impermanence loss?)
In a widely cited study on Uniswap v3 LP losses, rekt brutally stated that they (users) are better off HODLing than providing liquidity on Uniswap v3.
As shown in the article, during the launch period of V3 from May 5th to September 20th, 17 asset pools with TVL > 10 million US dollars (accounting for 43% of TVL), the transaction volume exceeded 100 B US dollars, and earned about $200 million fee. During the same period, however, losses due to IL exceeded $260 million, resulting in a net loss of more than $60 million. In other words, about 50% of V3's LPs are losing money.
While Uni V3 popularized the concept of leveraged liquidity provisioning - where the scope of transactions providing liquidity is narrowed and a higher degree of capital efficiency is achieved by eliminating unused collateral. This leverage increases the fees earned, but also increases the risk taken, as highly leveraged liquidity will face higher impermanent losses.
The reason goes back to the design goal of Uni V3: customized market making. For users, higher initiative means more complicated market-making operations. LP income depends on LP's ability to judge the market, which increases LP's decision-making cost and leads to unbalanced LP income. Adding and withdrawing LP positions within a block, which allows the scope of positions to be strictly defined to match transactions to poach the magnified portion of transaction fees).
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https://twitter.com/NateHindman/status/1457744185235288066? s= 20&t=jb-YsLK 25 pE 8 GuHZaMAudg
This leads to the next question: Will users lose money as LPs when they come to DEX to make markets?
Let's answer this question briefly:Whether a DEX market maker is profitable or not depends on the model of the pool that provides transactions, in addition to subjective ability.
There is no difference between the traditional AMM model pool - the profit logic of ordinary users providing liquidity and that of professional market makers. The funds and external quotations of market makers are limited by the AMM function. In essence, it is a contest of TVL, which determines who can share a higher handling fee.
Pools with customizable prices - such as Uni V3, Balancer V2, Curve V2, DODO V2. This kind of pool allows market makers to actively intervene in the pool's quotations. Market makers can use these tools to make profits through the price difference and lag between the CEX and DEX markets (at the same time, there are many DEX aggregators, and better quotations mean The pool will have a higher probability of being captured by the aggregator).
One of the reasons why LPs lose money is that they choose a plan that is not suitable for them.
Why does the top DEX provide a pool with a customizable price? Not only Uni V3, when the liquidity is evenly distributed on the curve, it will face the problems of high slippage and scattered liquidity. Therefore, traditional AMMs want to improve capital efficiency. The aforementioned Uni V3, Balancer V2, Curve V2, DODO V2, the direction of optimization is moving towards centralized liquidity.
In contrast, the advantage of active market making is that users can concentrate liquidity in a certain range by adjusting prices, etc., which improves capital efficiency, so the transaction has lower slippage and higher depth; but the disadvantage is also here, it To a certain extent, it raises the threshold for ordinary users to participate in market making. Compared with professional market makers, it is more suitable for professional market makers. The income of making money may increase, but we must admit that the risk of losing money also increases. After all, ordinary users It cannot compete with professional market makers in terms of professional skills and market sensitivity.
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03.
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market maker in dominoes
The FTX empire collapsed, a series of leading platforms were hit hard, and market makers and lending became the hardest hit areas: Alameda, one of the largest market makers in the cryptocurrency industry, was destroyed in this farce and officially closed on November 10 ; Genesis, a market maker and loan company under DCG, suspended redemption and new loan issuance due to insufficient solvency of the lending department due to the FTX mine explosion, and is seeking an emergency loan of US$1 billion from investors.
As a key part of the dominoes, what impact does the market maker bring:
Market liquidity has plummeted
FTX Thunderbolt Incident—Market Maker Collapse—Liquidity Gap.With the disappearance of top market makers, market liquidity can be expected to drop significantly.Other market makers will also suffer more losses due to the collapse of FTX, which will continue to widen the gap. A parallel to this is the brutal reality that cryptocurrency liquidity is dominated by only a handful of trading firms, including Wintermute, Amber Group, B2C2, Genesis, Cumberland, and Alameda. It was only half a year since the Three Arrows credit crisis in May and June. When the market casts a shadow again, market making becomes difficult.
According to Kaiko's data tracking, since CoinDesk announced the survey on Alameda's asset status, the liquidity of BTC within 2% of the median price has dropped from 11.8 k BTC to 7 k, the lowest level since early June. In this article, there is also a lot of data showing that the liquidity of the overall market was significantly affected by the Alameda crash and the losses suffered by other market makers.
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Source: Kaiko
Token Liquidity and Stress Test of Project Party
Alameda has invested in dozens of projects, holding millions of dollars worth of illiquid tokens (and since Alameda is also a market maker, they are also the main liquidity provider for these tokens). While the full breakdown of Alameda’s holdings with FTX is unclear, “it is a systemically important market maker,” according to FTX’s balance sheet details provided by the Financial Times. Especially for the liquidity of tokens other than BTC and ETH, for these project parties, the extreme market conditions brought about by the crash are undoubtedly a huge stress test.
For example, SOL (Solana), one of Alameda Research's heavily held tokens. Alameda held approximately $1.2 billion in SOL tokens on June 30, according to a CoinDesk report. SOL, one of the best-performing tokens in the 2021 bull run, is now down 95% from its all-time high.
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In the weeks following the implosion of FTX and Alameda, SOL plummeted from ~$35 to ~$11, a 68.5% drop
Source: TradingView
The double collapse of confidence and trust
What's more important is the double collapse of confidence and trust.
Confidence: The "Black Swan" incident has impacted the industry's confidence in the so-called high-performance public chain, and to a certain extent destroyed the confidence of users and supporters in a series of ecological projects under FTX. Faith is worth more than gold, and fear is worse than hell. The encryption market has experienced two Lehman moments within half a year. The Luna/Terra and Three Arrows Capital incidents have taught users what uncertainty is, and it has also brought a panic to the encryption market that is faster than virus infection.
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When the market becomes illiquid
As mentioned earlier, in any market, liquidity is the driving force behind it.
When the overall trend of the market goes down, the departure of top market makers will undoubtedly make things worse, which means that more projects and investments tend to be stagnant, so there will be another vicious circle here (until the fundamentals recover):
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Source: Kaiko
To maintain liquidity in the crypto market, many market makers provide liquidity to blockchain exchanges and financial protocols. thereforeIn the absence of market-making or a sharp drop in market-making activity, there may be low trading volume and reduced investment.Here we need to distinguish: liquidity will normally decline when it fluctuates, this is because market makers are drawing bid/bid tasks from the order book to manage risks and avoid bad liquidity; but major crisis events, market makers With the sharp decline caused by withdrawal, market liquidity will face severe challenges for a period of time.
It can be seen that the current liquidity decline is more serious than any previous market downturn, and the market recovery in the bear market is extremely slow, which shows thattext
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How does DODO meet market-making needs?
As mentioned earlier, we actually raised two main questions:
When AMMs are optimizing in the direction of concentrated liquidity, when becoming an LP to do the market may become a challenge or even a loss of money, how can market makers gain benefits?
When the FTX thunderstorm incident caused the collapse of the top market maker and the decline in market liquidity, how to rebuild trust and truly use the decentralized nature of the encrypted world to bring scarce liquidity to project parties? Bring real license-free and efficient transparency to market makers?
Regarding the second question, the answer is self-evident when it is asked: Use DEX, Use Blockchain. Let's go back to the chain, back to the code, and back to "don't trust, verify".
Regarding the first question, there are already many agreements or platforms in the market that provide corresponding liquidity management tools to help LPs manage risks and stabilize returns. Here may be a solution from DODO: let professional market makers enter the chain.
exist"Interview with DODO market maker: How to use DODO to improve market-making efficiency"In the article, the market maker Shadow Labs mentioned that after deducting gas and other expenses, it can obtain a net profit of 30-40% of the public income on the chain. For example, the market maker pool of WETH and USDC on DODO, after deducting various fees, the year-to-date net income of the market maker reaches $500,000, and the net rate of return is about 36.2%.
How to do it?
As we all know, AMMs are often referred to as "inert liquidity" because the price points offered to traders cannot be controlled, and are not as knowledgeable and flexible as traditional market makers. This is where DODO stepped in, and thus created the PMM (Proactive Market Making) algorithm. The PMM algorithm uses price predictions to adjust the pricing curve. The parameters are simple and extremely flexible. The flatter curve effectively improves the utilization rate of funds and reduces transaction slippage and impermanent losses. Regarding the efficiency improvement of different algorithms for centralized liquidity, please refer to "In-depth comparison of Uni V3, CurveV2, DODO market-making algorithms - efficiency improvement brought about by centralized liquidity"read.
In addition to these familiar content, we would like to talk about the V2 version of DODO launched in March this year. The DODO Private Pools (DPP), also known as private pools, are pools specially provided for professional market makers to make markets .
Private pools, as the name suggests, can be independently market-making by market makers providing their own funds, and the configuration of private pools can be flexibly modified during the market-making process, including transaction fee rates, current external guidance price i, curve slippage coefficient K, and simultaneous support Adjust the fund size of the pool, etc. All these modifications are realized by triggering the smart contract by the relevant account (including two methods, calling the DODO DPPProxy contract and directly calling the underlying private pool to make market-making modifications. For specific steps, please refer to: DODO V2 Private Pool Operation Instructions). Therefore, this pool mainly meets the market-making needs of professional market makers.
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Currently there is no DPP pool on Ethereum, and most market makers choose to build pools on the Polygon and BSC chains with lower gas fees
also,"In-depth comparison of Uni V3, CurveV2, and DODO market-making algorithms - the efficiency improvement brought about by centralized liquidity"In the article, the improvement of capital efficiency brought about by centralized liquidity is analyzed through the performance of liquidity distribution data. By selecting the market maker pool of WETH/USDC as a sample, the article shows the average value of the liquidity ratio between the price range of 2%, 6%, and 10%. The liquidity ratio of DODO V2's market maker pool is as high as 83.1% in the 2% range.
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About DODO
"DODO Research" is a Web3 investment research team, which continues to follow DeFi and related tracks, decodes the encrypted world with clear views and data insights, and discovers future value.
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