The History of Cypto Manipulation: The “Love and Hate” between market Makers, project teams and Exchanges

Author: Guangwu, Founder of Canoe


Former head of trade at FTX, @octopuuus, mentioned on the podcast that one perspective I’m interested in is the institutional perspective of market makers, “the history of banker manipulation”.

I’ll start by summarizing what he mentioned about Alamenda’s aggressive market maker style, and then add some other models that I’m aware of from the last cycle, especially the relationship between the project side and the market maker. The market makers mentioned in this article only refer to the part of the business that is associated with the exchange and the token of the project side.

Institutional trading perspective

From an institutional perspective, there are two main ways to control a token:

Strong banker control

In the case of good project fundamentals, select a target to start operation (project side may/may not know, it doesn’t matter)

The first stage(Accumulate): typical trend is to accumulate tokens at low prices.

The second stage is the consensus stage of market-making institutions. At this stage, the main metric is trading volume. First, pull up a band, and then change hands with other market makers in the shock (recover costs, improve capital utilization rate, and establish risk control model).

The third stage is the pump and dump stage. Further pull up, then dumping and boosting, this step some institutions will spontaneously assist the project side to do the fundamentals of the construction.

Make a value anchor for the target

This is to quickly improve the fundamental quality of the project in terms of capital and trading volume.

The best tools are lending and derivatives.

The example shared by @octupus is a loan, such as staking ftt to lend BTC/ETH, then the value anchor of FTT is BTC and ETH, the circular loan adds weight, and it is even possible to pump FTT using the borrowed BTC/ETH.

In addition, there are relatively professional futures (non-perpetual contracts that can be used as margin) and options. This is relatively complex. In the bull market, market makers in the currency circle do not even need to move this weapon, so they can complete the making.

The relationship between the project teams and the market makers

From the perspective of the project side, the relationship between the project and the market maker may be divided into the following types (large to top, small to ordinary studios) :

1. If the project party is actively seeking listing, cex will have requirements for the market maker:

a. Some even appoint some market makers. In the listing phase, market makers can help a lot, which is one reason why many project parties liked to invest in MM in the last cycle.

b. Market making accounts have margin requirements, such as token + USDT not less than $150,000, which usually could bargain.

2. The terms of a large market maker:

a. Passive market makers (much of this style in Europe) help to provide strategy and technical support. A strategy may charge $3, 000–5, 000 a month for several hundred projects

b. Technical service fee (about 6000 USD/quarter) + profit sharing (more of this style in China). Sharing refers to sharing the profit from selling tokens. Let’s say you sell a million dollars worth of merchandise, and then you split it. This kind of market maker and the project side have a certain interest binding, but the market maker has the initiative. When communicating terms, there is a key indicator is the reserve ratio: the market reserve capital/the market value. If you want to control the market, the ratio should be around 30% to 50%, in order to prevent the risk of collapse on the exchange (below the private price).

c. Another is a common tactic used by American market makers. Loan terms, such as finding the project side to borrow 3% of the token, after the expiration of the agreed price to return the principal and interest. Such a clause is illegal in the United States, so the clause generally explains the distinction between securities and obligations in the United States. The initiative is still on the side of the market maker, who can choose to return the token or the usdt. The project side has less right to speak.

a) return token is easier to understand, borrow what return what. There is a difference if it is USDT: some head market makers pay USDT at the price of the rotation in which they invest (which may float slightly). If exchange prices are much higher than private equity, market makers’ profits are terrible. Some market makers are more friendly and return USDT to the project side based on the average price of Binance Exchange on the agreed day. The average price is generally defined as daily volume weighted average price

b) Superpower of last cycle: private round of investment + borrowed a lot of tokens from a project side at private round prices. According to the above analysis, the market makers choose to maximize the profit. For example, if the price of the private round rises 100 times, the profit will be 100 times. In a sense, this is a cheap (or even zero cost) purchase of an American call option. The higher the pull, the greater the value of the option. Us financial counterparts are liquidity Service Level Agreements (SLAs), which strictly prohibit such terms.

3. The small market maker is simpler (they also have a project partner and incubator, has his own market making team, which is often referred to as a scythe) : they collects commissions and does whatever the project partner says. They will give you a daily update of the asset list and give you some advice and ideas. Unlike big market makers, with the project side basically very good communication, after all, the management of too many projects, and passive market making.

4. The best choice for the project side is to be strong on the exchange, the market maker cut off. Project side just build their own, their silent shipment, quiet sound to make a fortune. When trading volume is high, the bull market in Binance to reach $100 million trading volume is not difficult, the project side out of $1 million a day has no effect on the plate. Thus we can know why the project side in the middle of the bull market does not care vc quality, just want to exchange as soon as possible. For example, in the wave of gamefi in Vietnam, VC in the wave of tge directly back even ten times, the capital turnover efficiency is very high. Even within a month the money is back, and then the bear market slowly invested in good projects. But it’s easy to crash.

5. Add the downside of being cut off. The project side may lose money, if the project side unified hosting vc tokens, all out at a low price, and then by the market maker cut off, the project side estimated that they have to give money to the vc, what is more,keep build, token pump 100x without dump , the product problems back to zero, this is also many; It is the market makers who make money, and it is the project side who gets scolded. They take advantage of the market sentiment to pump the price 50x. The retail investors who take over at this price will scold the project side for a year. As mentioned above, generally the project side with good fundamentals is rule-based. The chips are open and transparent, and no money is willing to intervene in the token of the project side if it is disorderly.

Of course, market makers are not evil. They are simply money businesses. If the market is the riverbed, then the market maker is the end of the water supply. It is normal for the project side to have a weak voice in front of the market makers. In the secondary financial market, the water supply of the food chain is these market makers. But at the end of the day, they have their water, some of them lose or win or go bankrupt.

The relationship between market makers and exchanges

With all that said about exchanges, here’s the shadow banking system of market makers and exchanges:

● When liquidity dried up in the current bear market, leading exchanges frequently contacted market makers, begging them to help make markets and provide liquidity. Because liquidity is the fundamental infrastructure of an exchange.

● Back to the bull market. Why would an exchange use client assets to expand its balance sheet when its profits are so large? A large part of the exchange’s balance sheet is an unsecured line of credit to market makers, who use this money to continually increase liquidity and, in some cases, leverage it to provide ample liquidity. This gives market makers the right to embezzled their clients’ assets. When we were surprised by the huge liquidity in 2021, we thought these institutions were the saviors of the secondary market. When the real thunder came, we found that it was our retail investors who provided liquidity.

● Exchanges generally offer market makers a lot of conveniences: no fees, no collateral, low interest rates. Why is the 2021/2022 year market maker /Hedge Fund(e.g. 3AC) willing to pay 10% + interest year round when borrowing money, because some of this interest rate is paid by the exchange, not the market maker. Some exchanges often replace liquidity management costs by giving market makers unsecured loans for liquidity.

● FTX&Alamenda works this system to the Max, and when the exchange simply tops up market makers for liquidity, the shock is huge, and it ripples through every user. After FTX exploded, market liquidity plunged by more than 50%.

● In general, exchanges rely on market makers for liquidity, and market makers print money (unsecured loans) on the exchanges while making leveraged bets, resulting in a lot of financial thunderstorms/shadow banking debt crises, which happen to come from customer principal loans.

The relationship between market makers and AMMs

Of course, these are the last cycle of the script, the next cycle, how will play, nobody knows. For example, many of the new ventures for 2022 have hedge fund divisions to escape the profit squeeze of the market-making system.

About the relationship between projects and market makers, there are also some interesting things in the last cycle. One project I prefer is Merit Circle, which has raised 105 million dollars directly through LBP, and then opened to LP mining on Univ3/3. Its liquidity ranks in the top ten, second only to ETH/USDC. You can imagine the depth. And in LBP also finance enough money, does not matter on the place, but the trading volume is so large, or be strong on the currency. The gaming union now has $100 million in open Treasury assets during the deep Bear, and the address is monitored by the owner and updated daily in real time.

At the beginning, LBP was a fair launch, and later it became an excellent project liquidation exit tool when the market was good: it could make profits without the intervention of market makers and get rid of the profit system of exchange and market makers. At the same time, the flow pool after the end of LBP was also justified as the exit of VC.

Radical market makers will experience this round of deleveraging, and the market making business inside the exchange will undergo a great change in the next cycle. It will be a very interesting question to focus on the market making business, which means can be used to decentralize relevant business and divide authority and assets on-chain. In the last cycle, central market makers gradually became familiar with the DEX system. Meanwhile, some mainstream aggregator DeXs have introduced RFQ functions to serve professional market makers. Hashflow, which was put on the market recently, is also the main DEX of RFQ. However, the threshold for traditional real makers to enter the market making field of DEX is still relatively high, and it even takes 2–3 months to get familiar with it before they dare to use capital for MM market making. Meanwhile, the delay and performance problems of on-chain will still make many strategies ineffective. I expect a high performance chain-based trading engine and an engineering implementation without solidiy/vyper language constraints to further catalyse professional market makers to build liquidity in DEX and shift pricing power from CEX to DEX over the next cycle.

Another consideration is the question of market makers using AMMs to make markets. To market makers, AMM is a passive convex curve and coupled with inconstant losses, it is difficult to pump and control. When v3 came out, it was a little friendlier, but needed to move the price range frequently, making it difficult to manage market making. izumi manages v3’s function by discretization, but even after discretization, to that part of the definition domain, it is still passive convex curve, so liquidity management based on discretization cannot enable active market making and market control.

My future research direction is also related to this, such as whether to construct a new function form to realize passive to positive. Firstly, a mathematical definition of passive is constructed around t, and then a possible direction of thinking is to transform and eliminate t, just as Fourier transform transforms time domain functions into frequency domain functions. If market makers’ active management and leverage can be done at DeFi, the risks of the original shadow banking system can be greatly reduced.

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