The world of crypto market-making, once a lucrative venture, now faces turbulence. Investors' cautious approach, triggered by the crypto market's recent downturn, has put a dent in the profits of these facilitators. This caution comes in the wake of last year's crypto market crash, which saw around $2 trillion in value vanish. As a result, market-makers are adopting strategies to safeguard against potential upheavals, but these risk-mitigation measures are squeezing profit margins. In this article, we explore the challenges faced by crypto market-makers, their evolving strategies, and the shifting landscape of crypto liquidity.
The allure of market-making in the crypto world, where profits flowed from trading spreads, has encountered stormy waters. One significant factor behind this challenge is the newfound wariness among investors following the crypto market's sharp decline last year, which wiped out a staggering $2 trillion in value, as reported by Bloomberg.
The demise of exchanges like FTX has left a substantial amount of digital assets stranded on these collapsed platforms. This lingering uncertainty has prompted market-makers to adopt precautionary strategies, albeit at the cost of shrinking profit margins.
One key approach involves diversifying operations across multiple cryptocurrency exchanges, a move aimed at reducing concentration risk. Market-makers are also increasingly safeguarding digital assets away from trading venues, utilizing them as collateral to secure token borrowing for deployment on crypto platforms.
These collateral holdings are typically entrusted to custodians or prime brokers, ensuring that only the borrowed tokens are exposed in case of an exchange's failure. However, such risk-mitigation measures come at a price.
According to Bloomberg, employing intermediaries to manage collateral translates to a profitability reduction of 20% to 30% compared to directly leveraging coins on a trading platform. Despite these diminished margins, market participants are acknowledging the necessity of these strategies, recognizing that higher costs have become an inherent part of doing business in the crypto arena.
"The FTX debacle was a wake-up call for the industry," says Le Shi, head of trading at crypto-focused market-maker Auros. Leaving digital assets on exchanges without addressing associated risks was not always a priority, but attitudes have shifted. "…we understand higher cost is going to be a way of doing business now," Shi added.
Meanwhile, an examination of crypto exchange market depth, measuring the market's ability to absorb large orders without price impact, reveals diminished liquidity compared to the pandemic-era bull run. Crypto researcher Kaiko noted that the number of trades within 2% of Bitcoin's mid-price on exchanges has dropped over 60% since October 2022.
Bloomberg cited Kaiko's observation that this decline stems from a combination of structural factors, such as market-makers exiting the space due to losses and adjustments in risk management strategies post-FTX. Additionally, a low volatility environment has kept liquidity providers on the sidelines, further contributing to this liquidity reduction.
Crypto market-makers are confronting a transformed landscape where caution prevails and profitability is under pressure. While risk mitigation strategies come with a cost, market participants understand the need for these measures in the evolving crypto market. As liquidity wanes and structural changes reshape the industry, market-makers must navigate these challenges with adaptability and resilience, recognizing that the crypto market's dynamics continue to shift.
