The world of cryptocurrency market makers, once synonymous with substantial profits, finds itself grappling with a transformed landscape. According to Bloomberg, rising costs and investor caution following a $2 trillion market downturn have reshaped this sector’s dynamics.
Money-Market Struggles With Profit Margins
Market makers play a pivotal role in facilitating cryptocurrency trading by providing liquidity—offering to buy and sell digital assets like cryptocurrencies at quoted prices, earning profits from the bid-ask spread.
Market makers are being cautious as a result of the recent price drop, which has rendered platforms like the FTX exchange bankrupt, left a significant number of digital assets stranded, and caused. These companies are altering their strategies to navigate future uncertainty, even if it means lower profit margins.
Bloomberg stated that among liquidity providers like Auros, GSR Markets Ltd., and Wintermute Trading Ltd., diversification is a major trend. The number of cryptocurrency exchanges where they are active is growing, and they are increasingly keeping digital assets outside of trading platforms. Then, tokens are borrowed using these assets as collateral and deployed on cryptocurrency marketplaces.
By keeping collateral at custodians or prime brokers and exposing only the tokens obtained from lenders, market makers aim to mitigate risks associated with exchange failures. However, this approach comes with a 20%-30% reduction in profitability compared to directly depositing and leveraging coins on trading sites, as highlighted by Auros.
“The FTX debacle was a wake-up call for the industry,” said Le Shi, head of trading at Auros, emphasizing the newfound importance of minimizing asset exposure on exchanges, even if it means accepting higher operational costs.
While utilizing dedicated off-exchange custody providers can reduce risk, it also limits the scope for leveraging, and depository services often impose fees. The impact on profit margins varies significantly among different market-making companies.
The cryptocurrency market-making business thrived during the stimulus-driven bull run of 2021, with firms like Wintermute achieving remarkable results. The advantage of the difference between buying and selling prices showed bullish results during this period.
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Mounting Regulatory Pressure On Exchanges
The crypto market’s value has since declined from over $3 trillion to $1.1 trillion, influenced by higher interest rates and regulatory pressures in the United States, particularly on exchanges like Binance Holdings Ltd. and Coinbase Global Inc. Due to low trade volumes and declining volatility, market-making companies Jane Street Group and Jump Crypto have stepped back from digital assets.
Furthermore, Binance.US, the US subsidiary of a major crypto exchange, has witnessed a sharp decline in liquidity, with market makers and traders reportedly exiting the platform. The drop in liquidity suggests concerns related to regulation or other factors.
Market makers are now seeking to reduce their exposure to centralized exchanges and are focusing on larger cryptocurrencies like Bitcoin and Ether in a “flight to quality” strategy, explained Meng Hwee Neo, managing director of trading at GSR Markets. The majority of spot token trading happens on centralized exchanges, which are markets run by businesses like Binance, Coinbase, and OKX that assume custody of assets to make buying and selling easier.
Decreasing Trading Volumes In Crypto Derivatives
According to CCData, monthly spot trading volumes at centralized exchanges fell 74% to $445 billion in August from January 2022. Market makers also participate in the bigger futures and options market for digital assets in addition to spot tokens. During the same period, trading volumes for cryptocurrency derivatives decreased as well, roughly half to $1.5 trillion.
The ability of the digital asset market to support relatively large orders without adversely affecting an asset’s price is known as market depth, which demonstrates the withdrawal of liquidity providers. According to research firm Kaiko, the number of trades on centralized exchanges that are within 2% of the mid-price of Bitcoin has decreased by more than 60% since October of last year.
While digital assets have partially rebounded in 2023, they remain well below their all-time highs. Market players are optimistic about further gains, especially if the pending applications for the first spot Bitcoin ETFs in the US are approved. Some businesses are looking to Asia, where more lucid rules could boost local demand for cryptocurrencies.
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