Navigating the world of cryptocurrency market making can be challenging for Web3 founders. Ensuring liquidity is essential for both growth and stability in token economies, yet the processes involved often remain opaque and technically complex. This guide offers practical insights into engaging with market makers, helping founders make informed, strategic decisions.
Understanding Market Making Basics
Market making refers to the practice where an institution or trader simultaneously quotes both buy (bid) and sell (ask) prices for a security or asset to provide market liquidity. The bid price is the highest price a buyer is willing to pay, while the ask price is the lowest a seller is willing to accept. The difference between these two—the spread—constitutes the market maker’s profit margin.
By maintaining tight spreads and consistent liquidity, market makers attract more participants, which in turn increases trading volume and potential profits. Liquidity itself refers to how easily an asset can be bought or sold without causing significant price changes. High-liquidity markets have many active buyers and sellers, while low-liquidity markets can experience sharp price swings with larger orders.
However, a key challenge lies in aligning incentives: market makers often focus on short-term gains, while project teams usually prioritize long-term value creation.
Does Your Project Need a Market Maker?
Before engaging a market maker, founders should consider two central questions:
Is a Market Maker Necessary at This Stage?
Market makers are most beneficial in early listing phases—such as during an Initial Exchange Offering (IEO)—when organic trading volume is minimal. Established assets often have sufficient liquidity without dedicated market making.
What Are the Expected Benefits?
Projects designed for high-frequency trading (e.g., DeFi protocols) may require deeper liquidity. In contrast, governance tokens with lower trading velocity might only need a simple 50/50 liquidity pool on a decentralized exchange. As projects scale and gain user traction, migrating to centralized exchanges may become a more suitable option.
Weighing the Advantages and Costs
Benefits of Using a Market Maker
- Tighter Spreads: Lower bid-ask spreads reduce trading costs and improve the user experience.
- Liquidity Attracts Liquidity: Initial market presence can trigger a positive feedback loop, drawing more traders.
- Improved Price Discovery: Liquid markets help reflect the true value of an asset based on collective trading activity.
- Price Stability: Higher liquidity cushions the impact of large orders, reducing volatility.
Associated Costs
- Fees: Market makers may charge setup fees, recurring monthly fees, or require token loans.
- Negotiation Imbalance: Newer projects with lower trading volumes often have less bargaining power.
- Risk of Bad Actors: The lack of regulation in crypto can attract fraudulent market makers who may engage in practices like wash trading.
How to Choose the Right Market Maker
With over 50 major market makers operating in the crypto space, founders should evaluate candidates based on:
- Fee Structure: Compare setup, recurring, and performance-based fees.
- Capability: Assess their ability to maintain tight spreads and support desired trading volumes.
- Reputation: Look for established firms with strong balance sheets and a track record of delta-neutral market making.
- Accessibility: Ensure they are willing to work with projects at your stage and size.
- Exchange Relationships: Consider their existing connections with major exchanges, though this should not be the sole deciding factor.
👉 Compare professional market making services
Key Contract Terms to Negotiate
A Market Making Agreement or Liquidity Consulting Agreement (LCA) should be carefully structured to align interests. Critical components include:
Compensation Structures
- Service Fees: Fixed payments such as setup or monthly retention fees.
- Options Agreements: Grants the market maker the right to buy tokens at a preset price. This can create incentives but also carries risks of mispricing or short-termism.
- Performance-Based Fees: Incentives tied to metrics like spread depth, minimum order sizes, or volume—though volume-based KPIs can encourage wash trading.
Loan Terms
Many agreements involve lending tokens to the market maker. Key terms include:
- Loan duration
- Interest rates (typically zero in crypto)
- The number and type of tokens loaned
- Repayment conditions in case of default
Termination Rights
Contracts should clearly outline conditions under which either party can terminate the agreement, including notice periods and breach clauses.
Liability Clauses
Most agreements exempt market makers from liability related to token price volatility, given the speculative and multifactorial nature of crypto markets.
Frequently Asked Questions
What is the main role of a market maker in crypto?
Market makers provide liquidity by continuously quoting buy and sell prices. They help reduce spreads, improve trade execution, and stabilize prices.
How do market makers make money?
They profit from the bid-ask spread. By buying at the bid price and selling at the ask, they capture small gains on each trade, which accumulate with volume.
Can small projects afford market making services?
It depends on the fee structure. Some market makers offer performance-based pricing, while others require upfront payments. Founders should assess their budget and stage of growth before committing.
What are the risks of using options in compensation?
Options can lead to misaligned incentives. If priced incorrectly, they might encourage short-term price pumping or create excessive sell pressure.
How can I verify a market maker’s reputation?
Review their past partnerships, ask for case studies or references, and look for feedback from other founders in the industry.
Are there alternatives to traditional market makers?
Yes, some projects use decentralized market making protocols or bootstrap liquidity via liquidity mining programs.
Conclusion
Selecting and negotiating with a market maker is a critical step for Web3 founders aiming to ensure token liquidity and stability. By focusing on transparent agreements, aligned incentives, and rigorous due diligence, founders can foster productive relationships that support long-term project goals.