How token-based businesses should tackle market making: Outsource, do it yourself, or do nothing at all?

Utility tokens in crypto markets

Utility tokens continue to proliferate and trading on a range of crypto exchanges comes with varying levels of volume and liquidity. Additionally, a large number of smaller cap utility tokens are trading in illiquid markets.

Utility tokens are needed in order to transact on various platforms or exchanges. For example, a borrower or a lender on Lendingblock’s exchange will need to pay interest fees with LND, Lendingblock’s utility token.

With this in mind, the role of market makers becomes paramount to users and operators of utility-based exchanges and platforms.

Liquidity and market making

A market is considered liquid if a participant can enter or exit from positions in an instrument with immediacy and without suffering adverse costs in the form of large spreads or slippage. Slippage occurs when the participant’s trade cannot be executed at, or close to, the front of the order book (the front of the book is where the best price is provided).

This results in the trade filling orders at prices away from the best price, and therefore, participants incur costs higher than would be the case at the quoted best price. Markets with large spreads or thin order books are described as illiquid.

Market makers provide a particularly vital service in illiquid markets. They operate by placing orders on both sides of the order book, offering to both buy and sell, therefore providing market depth. The goal of a market maker is to make so-called ‘round-trip’ trades. These occur when both their buy and sell orders are filled, resulting in a profit from the bid-ask spread.

Competition between market makers is also key to healthy markets. As market makers vie to have their orders executed, they compete to place orders near the front of the order book. This results in a decrease in spread and an increase of depth at the front of the order book. For the liquidity taking participant this reduces cost in the form of spread and allows larger orders to be executed immediately without suffering unacceptable slippage.

Stepping up to the plate

In relation to market making, utility token-based platforms have three options:

  1. Not make markets on the token

This is a less than ideal situation because others may step in if they see there is a liquid market, and this means your token is at the markets disposal and ultimately will not deliver the healthiest and most balanced buy and sell market place for market participants possible. Worse, liquidity may remain poor resulting in prohibitive difficulty accessing the token’s platform.

  1. Outsource

Every market maker depends on bid/offer spreads to stay in business. When exchanges outsource this function, the market maker charges both the investor and the exchange. An external resource also holds no incentive to keep spreads tight—or at least as tight as the market allows them to be.

  1. Establish market making in-house

This option, in our view, is much the preferred option—here’s why.

In-house market making is best practice

Given our commitment to excellence and transparency, leaving clients high and dry was an unacceptable course of action. That approach runs contrary to our desire to be in the vanguard of the players who are setting the standards for the crypto industry, particularly for us, this pertains to institutional digital asset lending. As an option, outsourcing is expensive and would not keep us as close to the market as we and our clients would like. Whereas, in-house market making gives us the high degree of control we require and provides our investors with both the liquidity and transparency they expect, as we are motivated not by trading profits but by facilitating the use of our platform. By providing the necessary liquidity from our own resources, orders are executed quickly and efficiently. Furthermore, our clients can be confident that our aim is to facilitate usage of the Lendingblock platform, rather than market making as a primary source of revenue. Those benefits—coupled with a feature-rich and streamlined lending exchange—all contribute to an efficient and satisfying client experience.

If you are interested in borrowing and lending your firm’s digital assets, click here to create an institutional account.

How token-based businesses should tackle market making: Outsource, do it yourself, or do nothing at all?
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