Glossary
- Market Maker: A financial institution or individual that provides liquidity to a market by quoting bid and ask prices and actively buying and selling securities or other financial instruments.
- Bid: The highest price at which a buyer is willing to purchase a security or financial instrument. It represents the demand side of the market, and market makers provide bid prices at which they are willing to buy securities from potential sellers.
- Ask: The lowest price at which a seller is willing to sell a security or financial instrument. It represents the supply side of the market, and market makers provide ask prices at which they are willing to sell securities to potential buyers.
- Bid/Ask Spread: The difference between the highest price (bid) that a market maker is willing to pay for a security or financial instrument, and the lowest price (ask) at which they are willing to sell it. It represents the cost of trading and the profit potential for market makers.
- Liquidity: The ease with which a security or financial instrument can be bought or sold without significantly affecting its price. Market makers play a crucial role in providing liquidity to markets by buying and selling securities to ensure smooth trading.
- Market Depth: The measure of the quantity of buy and sell orders at different price levels for a security or financial instrument. Market makers closely monitor market depth to assess supply and demand dynamics and adjust their bid and ask prices accordingly.
- Order Book: A digital record of all outstanding buy and sell orders for a security or financial instrument, organized by price level. Market makers use the order book to gauge market sentiment and make pricing decisions.
- Quote: The bid and ask prices that a market maker provides for a security or financial instrument. Quotes are typically displayed on electronic trading platforms and reflect the market maker's willingness to buy or sell at those prices.
- Arbitrage: The practice of taking advantage of price discrepancies in different markets or instruments to make a risk-free profit. Market makers may engage in arbitrage strategies to capture small price differences between different trading venues or related securities.
- Spread Capture: The process of earning profits as a market maker by buying securities at the bid price and selling them at the ask price, capturing the difference as profit. Market makers aim to capture as much of the bid-ask spread as possible to generate revenue.
- Market Volatility: The measure of the magnitude of price fluctuations in a security or financial instrument. Market makers need to consider market volatility when pricing their quotes and managing their trading activities, as higher volatility can increase trading risks.
- Options: Financial contracts that give the holder the right, but not the obligation, to buy (call option) or sell (put option) a security or financial instrument at a predetermined price (strike price) within a specified period of time (expiration date). Market makers may provide liquidity in options markets by quoting bid and ask prices for options contracts.
- Strike Price: Also known as the exercise price, it is the price at which the holder of an options contract can buy (in the case of a call option) or sell (in the case of a put option) the underlying security or financial instrument. The strike price is predetermined at the time the options contract is issued and is an important factor in determining the value of the options contract.
List of potential founder considerations
- Perform due diligence of the firm’s potential partnerships:
- Top-tier crypto MMs may have partnerships with leading exchanges, including Binance, Coinbase, Huobi, Crypto.com etc. Through a MM relationship, a project can more easily list their token through a combination of social proof from the trusted MM and guaranteed liquidity.
- Watch out for red flags:
- Volume targets
- Profit sharing agreements
- Service fees
- Any miscellaneous signs of illegal activity, including but not limited to wash trading and involvements in pump-and-dump schemes.
- Consider the quality of the deal terms that have been offered, including factors such as (these will be explored more deeply in the next section):
- Price
- Options
- Loan terms
- Liability
Criticisms of MM and high-level purpose of paper
Market making as a practice is currently under some degree of scrutiny following the events of FTX and its market maker Alameda Research. The collapse showcased some of the predatory behaviour undertaken by market makers. However, market makers are a crucial component of any crypto ecosystem with tokens and liquid tokens, and this report is an all-in-one guide for navigating the market making space as a project founder or core member.