Crypto market makers rake in cash shorting their customers’ tokens. One firm is calling for more transparency

To say crypto market makers are unpopular is somewhat of an understatement.

Controversies at several crypto market makers in recent years have soured public opinion, and left many in the industry with a lingering suspicion that such firms manipulate markets and exploit both traders and their own customers for profit.

“Market making in general has a very negative perception,” Wesley Pryor, founder of market-making firm Acheron Trading, told DL News. “It’s viewed as predatory. But really, market making is one of the most critical components for the digital asset ecosystem to actually operate.”

Crypto projects rely on market makers to ensure their tokens are liquid across exchanges, minimising price volatility and providing better prices for buyers and sellers. “Everyone needs a market maker to go to market. It’s a foundational component,” Pryor said.

But ensuring ample liquidity is often secondary to many market makers. Instead, they engage in what Pryor calls “parasitic” strategies that are designed primarily to ramp up the firm’s profits instead of minimising price volatility.

Some market makers, Pryor said, even trade against the projects that hire them by shorting their tokens.

The problem is so big that firms such as Coinwatch and Glass Markets have said they will make sure that the market makers their clients hire aren’t misbehaving.

Pryor said Acheron has made its market-making activities more transparent than its peers to help combat the negative perception of market makers.

This, Acheron hopes, will prove that it is acting honestly and in the best interests of its clients, and help rebuild trust within the broader crypto community.

But doing so might be difficult.

Pryor said that Acheron may forgo profits that other market-making firms can earn, something that could make it less competitive.

And not all market makers agree with Acheron’s call for absolute transparency.

“As long as market makers don’t do anything that can be perceived as market manipulation, they have the right to operate in private just like any other normal market participant,” Evgeny Gaevoy, CEO of market-making firm Wintermute, told DL News.

What does a bad market maker look like?

The most common kind of market-making deal in crypto is called the loan and call option model. Here the market maker uses tokens loaned from its client in its market-making activities while also receiving a call option on them — the ability to buy those tokens at a predetermined price at the end of the market-making deal.

These loan and call option deals, Pryor said, are where most of the parasitic market making happens.

Market makers are protected by a big price increase in the asset they are making markets for by the call option. If the asset trades higher, they can use the call option to buy the asset at a lower price and immediately sell it for a profit.

This makes it lucrative for a market maker to drive up the price of an asset when it starts trading and then short it from the inflated price.

“They’ll sit on the sidelines, they’ll let the asset trade up on the initial market open, and they won’t provide any liquidity at the opening price,” Pryor said. “They wait for the market to spike, frenzy, and FOMO. Then the market maker steps in and starts shorting the asset.”

Shorts are bearish bets on the price of an asset. It refers to borrowing an asset and immediately selling it on the market in the hope of buying it back later at a lower price and pocketing the difference when returning it to the lender.

Shorting tokens isn’t necessarily bad. Many market makers use shorting as a tool to stay delta neutral — a term that means their position mitigates the risks of tokens increasing or decreasing in value.

Examples of ‘misuse’

According to Matt Jobbe-Duval, CEO and co-founder of market maker monitoring firm Coinwatch, market makers misusing shorting is all too common.

“Coinwatch makes sure that market makers don’t misuse the tokens. Some examples of such misuse are shorting the tokens and front-running token unlocks,” Jobbe-Duval told DL News.

In a December blog post, Acheron said the high volatility of the PYTH and WLD token launches was “indicative of a market environment that is more susceptible to manipulation or influence from market makers, who might prioritise their own gains over orderly price discovery in the token’s initial period.”

And Acheron is not the only one to raise issues with the WLD token markets.

Matt Batsinelas, founder of crypto market data provider Glass Markets, previously told DL News that the loan and call option deals Worldcoin made with market makers gave them an incentive to push up the WLD token’s price on its July launch.

“People can lose a lot of money just buying these things at launch,” Batsinelas said at the time.

Worldcoin didn’t respond to a request for comment at the time.

And according to Gaevoy, it’s not just the projects themselves that can help keep their market makers in check.

“Exchanges are the natural ‘regulator’ to weed out bad actors,” Gaevoy said. “Yet we hardly see any announcements from any exchanges, big or small, about trading firms being fined or banned. This just doesn’t happen.”

Calls for greater transparency

Coinwatch’s Jobbe-Duval said market makers should be doing several things to help shed the negative perception many have of them.

He explained market makers could make it easier for their clients to terminate contracts for underperformance and agree to be more transparent with their reporting and how they will manage token loans.

“Market makers do this today for projects that have hired Coinwatch to keep their market makers in check, but they don’t do it by default for everybody,” Jobbe-Duval said.

In Acheron’s view, the remedy to bad market-making practices is establishing a norm of transparency across the industry. It plans to do that by providing real-time data of its market-making activities to clients, as well as offering flexible contracts that don’t enforce nondisclosure agreements over their terms.

“We give real-time access to our liquidity performance indicators to any project that’s working with us, regardless of the financial structure,” Pryor said.

Wintermute’s Gaevoy agreed that “disclosures would be generally a great development,” but countered that that doesn’t mean market makers should generally be more transparent.

And it isn’t always up to the market maker if they are transparent about their activities, Gaevoy added. “If they do liquidity provision for a protocol, I would argue it is up to the protocol to disclose the details of the engagement,” he said.

But for Acheron and other firms looking to improve the image of market makers, it may be an uphill battle.

When asked if he thought there was sufficient transparency among market-making firms, “No,” Jobbe-Duval replied, without elaborating further.

Tim Craig is DL News’ Edinburgh-based DeFi Correspondent. Reach out with tips at tim@dlnews.com.