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Industry experts have lamented the loss of liquidity in crypto markets ever since market maker Alameda Research collapsed in 2022. Thinly-traded markets saw the Bitcoin (BTC) price moved by smaller trades, but market maker Keyrock argues how genuine market making, rather than wash trading, can offer better price consistency.
Fast-forward several months and the Bitcoin price has stabilized somewhat, but liquidity issues remain as institutional inflows stagnate. The asset suffers from a shortage of market makers offering deep liquidity to prop-up trading activity.
In an interview with BE[IN]CRYPTO, Stef Wynendaele of Keyrock, a crypto market maker, says diverse market makers strengthen a token’s market. They also contribute to the price consistency of an asset across exchanges.
But what exactly is a market maker?
We dive deep into the inner workings of these unsung heroes, which offer critical liquidity key to propelling the engine of capitalism. We then examine their key role in ensuring trades execute smoothly in crypto.
How a Market Maker Helps Traditional Stock Trading
In traditional markets, market makers place bids and offers (ask) spreads for a minimum number of shares at multiple levels of an order book. Top US market makers providing liquidity on the New York Stock Exchange (NYSE) and the Nasdaq include Credit Suisse, Deutsche Bank, and Goldman Sachs.
Once a market maker receives an order from a buyer, generally a broker, they sell their shares. They profit from the difference between the price at which a broker buys the stock and what they, the market maker, sell it for.
Market makers must abide by exchange rules a country’s securities authority sets. A robust and deep pool of market makers assures investors they can easily liquidate assets.
Crypto Exchanges’ Multiple Roles Cause Problems
While their description may evoke images of the NYSE, crypto exchanges, more often than not, differ significantly from conventional trading venues.
Despite their name, crypto exchanges combine multiple roles to offer traders a one-stop solution. In addition to providing customers with an order book to buy and sell cryptocurrencies, exchanges can act as trade counterparties, custodians, lenders, and borrowers.
Their role as custodians means that exchanges effectively function as brokers who can choose to trade against customers. National Bureau of Economic Research (NBER) studies have shown that investors do not always receive the best price.
Crypto market makers fulfill a vital function in the industry. Discover some of the more prominent ones here.
In addition, customers can be harmed through a predatory practice where exchanges cook order books to inflate trading activity. Through a technique known as wash trading, exchanges can place and fulfill multiple bids at the same price and size. This results in orders filled by the same entity, creating an illusion of high trading volumes for a specific token.
A 2019 study by San Francisco-based asset manager Bitwise found that smaller crypto exchanges spoof trading volumes to boost business. To do this, the exchange will create multiple successive orders on a single crypto asset using fake accounts operated manually or through a trading bot.
It then fills these orders, creating an illusion of high trading volumes. The fake volume boosts a token’s public perception and invites more trades, creating a positive feedback loop.
A 2023 paper by the NBER found that wash trading accounts for about 77.5% of volumes on exchanges considered unregulated by New York state law. Wash trades on 12 so-called Tier 2 exchanges accounted for 80% of trading volumes.
Tier 2 exchanges fell outside the top 700 of the SimilarWeb website traffic ranking in the investment category for the period covered in the study.
Keyrock is a Crypto Market Maker
However, it’s not all doom and gloom for crypto investors, according to market-maker Keyrock. The company buys and sells digital assets to traders, investors, and market participants.
Rather than promoting fake trades, the Brussels-headquartered company protects traders from volatility by placing multiple bids and asks spreads across an exchange’s order book. It mitigates its own risk through large spreads between its ask and bid prices.
The firm powers liquid markets at some of the world’s most prominent companies, including Kraken, Binance, KuCoin, Crypto.com, and Huobi.
In a recent interview with BE[IN]CRYPTO, Keyrock executive Stef Wynendaele affirmed the importance of relying on multiple liquidity providers.
“[Through] friendly competition, token projects will have healthier markets as there are multiple market makers placing bids and asks on multiple levels.”
He added the variations in uptime, depth, and bid-ask sizes per agreed points distance benefit token markets. Liquid order books ensure greater price consistency across exchanges, he adds.
Proactive Regulation Better Than Enforcement: Wynendaele
Last year, the collapse of FTX was partly caused by the illiquidity of the FTT token its market maker Alameda Research held. Congressman Ritchie Torres alleged the US Securities and Exchange Commission (SEC) should have acted early to protect US investors from the fallout.
Since then, the SEC has been engaged in a war of attrition with crypto exchanges that argue for clearer regulation. For its part, the SEC says exchanges must comply with current laws or face consequences.
Wynendaele agreed with Torres on the merits of being proactive rather than reactive.
“Rather than abolishing a policy or regulation, we’d welcome more proactive guidelines from lawmakers around the world. This means actively monitoring the evolving landscape and determining where specific regulatory measures are necessary.”
MiCA Holds Promise But Practical Realities Unknown
In particular, Wynendaele lauds the progress the European Union’s Markets in Crypto-Assets (MiCA) bill offers.
However, he pointed out that it remains to be seen how the laws play out at the national level. MiCA rules state that exchanges must register with local authorities in any EU member state to operate across the region. Still, enacting the law will test how fast authorities can work.
“Cryptoasset service providers… hope that regulators proactively engage in ensuring that license applications are reviewed in a timely manner.”
The Dutch central bank has already approved 37 crypto companies, including Crypto.com. France’s Autorité des marchés financiers (AMF) has licensed Binance and the crypto arm of banking giant Société Générale.
And Swarm, a company allowing tokenizing of real-world assets for decentralized finance, has secured a license from Germany’s finance regulator BaFin. MiCA is expected to go into force in late 2024.