Market Making Unmasked

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Bitcoin and cryptocurrency is a quickly emerging new asset class — complete with Futures and perhaps ETFs to come. So here is something that isn’t as openly or frequently discussed in mainstream media: market making.

This is something which is rampant in the traditional securities asset class and has been for a long time, as market makers constantly influence the charts on many of the stock exchanges.

WTF is a market maker?

If you’re like me, then you most probably haven’t even come across this term in the past and most likely haven’t bothered to do any research on this matter. You could say that part of the reason that I’m writing this article is to help all the other “me”s out there. So let’s start with investopedia, a very reliable source for definitions within the space:

A market maker is a “market participant” […] a market maker can enter and adjust quotes to buy or sell, enter, and execute orders, and clear those orders.

A (good) market maker is not a “dumper”, “thief” or a “wash trader” (faking volume), as Investopedia then goes on to say that “ Market makers exist under rules created by stock exchanges approved by a securities regulator.Going back to the point that crypto is a completely new and emerging asset class, the SEC has not yet revealed its stance for market makers within the space, however, we can expect that the same rules will apply here and that only regulated market makers may enter the space, complete with all the paperwork.

(Good) Market makers should not have to promise a certain price for a token, nor should they have to promise a certain volume either. Instead, what a good market maker will do is provide incentives for other market participants to take action (sell and buy). Market makers should support any decision from any of the market participants. They should sell when others want to buy and should buy when others want to sell. A market maker provides liquidity and allows room for speculation, so that other market participants (e.g. traders) are attracted to that specific token.

Examples

All these definitions are quite simple to grasp thus far, so now let’s see what a market maker in action actually LOOKS like on a real graph. Remember, a good market maker should not have to fake the volume or overtly manipulate the price of any token. The key word here is influence.

Above we have [redacted name] token. A token which has raised my suspicion, pointing towards the fact that this token could be market made. Below I will make my case as to explain why I think that and break down my reasoning. I am redacting the name of this token in order to protect their reputation and brand. I don’t say this because I believe that market making is wrong or something that should be hidden and “hushed away”, but I do acknowledge the stereotypes and general stance towards market making which exist.

We can see that prior to the 28th of September, this token did not have much traction or volume as seen in “C”, this is due to a lack of market participants. This could be because of many reasons, such as not being listed on a significant exchange, not having enough liquidity or simply low awareness.

However, we can see that at “A”, on the 28th of September there was a massive “pump”. Many of you are probably thinking that this is a manipulated event. However, this sudden increase in price and volume was actually caused by significant news about this token, driving awareness up and creating “FOMO”. Since I have chosen to redact the name of the token, it is a little bit tricky, so you’ll just have to take my word for it on this one. The second reason why I don’t believe that this is a manipulated pump is because of the way it reaches equilibrium as seen in “B”. Following the FOMO pump, the token is clearly overvalued and the price must once again “normalize”. The stepping down of the price to its real value is done in a “hiccup” manner, as opposed to a straight line (BitConnect anyone?).

This to me signifies that the market maker was there to catch the token as its value was declining and people were taking profits. The market maker was filling sell orders, and thus buying up tokens in order to further support the market, as is shown in the stabilization of the price after the fact. Lastly, we can see that the market maker is supplying adequate daily trading volume at “D”, in order to allow market participants to either enter or liquidate their positions. The graph itself also is not a straight line and is clearly bound by a range, which is something that technical analysts and traders alike tend to flock towards. This token is likely a safe bet to place sell orders at a certain price point and buy orders at another. This is a token which more closely resembles graphs from the stock market, something we must get used to if cryptocurrency is to become mainstream.

Although this token is a little more rough with its graph and seemingly random (hint), there is reason to believe that someone is influencing its volume and price.

So once again we have all the signs as seen in the previous token. There is (relatively) low volume due to decreased market participants, then an event takes place which drives the price up, followed by the stabilization of the price above its starting point which is once again done in a “hiccup” manner, signifying that someone must be buying back all these tokens. Volume then proceeds to find its footing post-spike, also above its starting point.

“Hmm… this graph seems familiar” it does, doesn’t it? That’s because what I’ve just shown you is the graph for Bitcoin (BTC). “Oh wow, so you are suggesting that someone is market making BTC?”. Yes. That is exactly what I am suggesting. The market makers for BTC are comprised of 2 parties. The first one being you and I (the general population) which has vested interest in BTC (buys, sells, talks about it). We are Bitcoin’s main face and part of the reason why its value is where it is, but also part of the reason why Bitcoin has been so volatile in the past. Since we (the people) are comprised of many individuals which are not operating on a hive-mind level, and because our decision-making is heavily affected by emotions, it has been extremely hard to make any predictions of the BTC price in the past.

However, there is a second party which lurks in the shadows. This party does not talk much, nor do they express their feelings. They merely act upon the market. Sometimes we feel their wrath, and other times we take joy by their actions. I am, of course, referring to the Bitcoin whales. These are the guys who own massive, almost incomprehensible amounts of BTC. It is clear that BTC whales DO operate on some kind of hive-mind level, whether that be through algorithmic trading / analysis or collusion, we don’t know! If it were up to them, BTC would probably not have been as volatile, however at the same time, if BTC had not been as volatile perhaps many of them wouldn’t exist today. It is also clear that, for better or worse, they have been accumulating BTC throughout this whole bear market. They initiate the market action, they influence the graph such that FOMO and FUD are created, Bitcoin is moulded by their image.

Since there are two parties at play in the “market-making” of Bitcoin, it also means that this token is much more likely to be heavily affected by news and the average market feeling, as the Bitcoin whales are not enough to support the market. Bitcoin “dumps” may not be inherently bad for whales either, so there is the chance that they might also let it happen in order for them to accumulate. Bitcoin itself is on a whole other level when it comes to crypto, as it represents the industry standard. Bitcoin is much more likely to go through market cycles than a normal token or security which is properly market made (often with algorithms). The only reason I have decided to include BTC as an example here is to make a point that market-making is neither a) a rare occurrence or b) a scam.

Conclusion

  • Market making is something which is practiced in traditional markets already. It only lacks regulation within crypto.
  • Market making helps crypto by removing “scam tokens” and creating a safe environment for market participants.
  • Market making has nothing to do with pumping and dumping on people. Rather it is an encouraging tool which projects can use to ensure liquidity, awareness and market action for their token.
  • Some projects do not need market making, and that’s okay!
  • While market making is not inherently bad, some people with self-interest at heart within the space have brought a bad reputation to market makers.

 

Source: Lawrence S. on Medium