Decoding Market Makers' Role in Cryptocurrency Listings: A Call for Fair Price Discovery
Summary:
The article discusses the role of market makers (MMs) in cryptocurrency token launches and highlights issues with parasitic and transitory strategies. These approaches manipulate token prices during listings, impeding fair price discovery and often hurting token communities. A symbiotic strategy, which encourages stable value growth and accurate price determination, is endorsed. The article suggests using the Relative Change in Volatility (RCV) methodology as a tool to evaluate how MMs set up initial order books for more effective price discovery in the digital asset market.
Do all cryptocurrencies operate on a pump-and-dump framework? This is a question many people often ask due to the familiar trend of digital currencies soaring to unsustainable heights upon being listed on a new exchange, only to later plummet dramatically, leaving investors with devalued assets. But who's behind this cyclical pattern? It's the market makers – firms that are hired by crypto projects to control the initial trading tokens when they debut on new exchanges.
Think of a crypto's debut on public market trading as an Initial Public Offering (IPO) – it's a similar transition from private to public markets, with one key variation. Digital asset issuers commonly set the opening price of a digital asset downright low, resulting in much better first-day performance than traditional markets.
Let's unpack this in relation to traditional markets. Here, shares are mainly in the hands of passive investors, but in digital asset markets, tokens should ideally be in the custody of active participants. The success of a token market is entirely dependent on the potency of its holders. This is where it diverges from traditional IPOs, where investment banks set the prices. Public round token prices are typically lower than the fair market price, resulting in image-boosting first day "pops" on digital markets.
During a primary listing, a market maker, or MM, puts a large chunk of a token's circulating supply up for sale on an exchange's pre-market order book, allowing them to set the liquidity ahead of public trading. The intent is to ensure ample liquidity provisioning for efficient price determination when trading commences. However, not all MMs are created equal, with some short-changing order books to inflate short-term profits, consequently injuring the token community and the project. This is known as "parasitic" market making, a practice that favors MM profits over market wellbeing.
Now, here are the varying strategies of liquidity supply during a primary listing via pre-market order construction.
Parasitic: Parasitic MMs exploit initial demand by creating artificial scarcity and manipulating market sentiment. They wait for retail bids to rise before aggressively shorting the token and placing high sell orders to quench demand, leading to a decline in the token price. This unsavory approach often inflicts lasting market damage.
Transitory: The parasitic MM manipulates the pre-market order book, overshooting sell orders to fill their pockets with fees or close Over-the-Counter trades. This method results in a hasty market exit, suppressing potential price upside by excessively selling off the token.
Symbiotic: The MM uses its understanding of the pre-market order book to set a strategic course for its opening liquidity, building long-term value and ensuring accurate price representation. By providing liquidity on both ends, the MM fosters an orderly price determination process that reflects the asset's genuine market value.
To illustrate how MMs differ, we gauged the price multiple performance of tokens during two key periods: The first two days post-listing (analyzed hourly) and the initial two weeks (analyzed daily). We based our analysis on the Relative Change in Volatility (RCV), evaluating the change in volatility with and without a token's highest price ever. A positive value indicates an undersupplied order book and a lack of pre-market liquidity. Conversely, a negative value denotes an oversupplied order book or aggressive market making, and therefore an overpriced asset. A zero value suggests that liquidity is balanced for orderly price determination.
Applying the RCV methodology to 93 listings from April 2024 onwards to Binance, Bybit, Coinbase, Kucoin, Kraken, and OKX, we found that 69.9% of primary listings were "Parasitic," 8.6% were "Transitory," and only 21.5% had a "Symbiotic" approach. This means that 78.5% of launches disrupted fair price discovery, negatively impacting both users and projects.
For Parasitic launches, including the all-time high point brought about a 420% surge in market volatility, leading to severe undersupply, bloated prices, and eventual market desertion. On the flip side, Transitory launches saw a 34% reduction in volatility when incorporating the high point, pointing to a glutted order book where the initial supply was poorly managed to the MM's advantage.
Both Parasitic and Transitory approaches undermine price discovery, lessening chances of sustained market engagement. Symbiotic approaches, however, yielded an RCV of around plus-or-minus 20%, establishing a stable basis for fair and sustainable price discovery processes.
As the digital asset industry continues to expand, it is crucial that market makers rectify the pervasive mishandling of primary listings. Asset issuers and exchanges should choose and scrutinize market makers by applying the RCV methodology to ensure they are properly setting up initial order books. It's high time this industry addressed the harmful practices of parasitic operators and held MMs accountable for enabling healthy price discovery.
The views, thoughts, and opinions stated in this piece belong solely to the author and do not necessarily reflect those of Cointelegraph. This article is for informational purposes only and should not be taken as investment or legal advice.
Published At
6/24/2024 7:47:20 PM
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