Few ordinary crypto holders understand the role of market makers.
At the simplest level, market makers provide liquidity to keep assets tradable in the cryptocurrency market, ensuring that if a user tries to buy or sell a coin on a particular exchange, they’re usually able to.
However, unethical market makers also manipulate token prices, inflate volumes and conduct pump and dumps.
Many cryptocurrency projects hire them to goose their performance metrics using strategies like wash trading, which is where entities repeatedly trade the same asset back and forth to create the illusion of volume. In traditional markets, this is illegal market manipulation, misleading investors about the demand for a particular asset.
“A lot of [token] projects are fooling their own trader community or investors by faking these wash trades or these volumes,” says Mathias Beke, co-founder and head of trading at Belgium-based market maker Kairon Labs.
He adds that these cowboys give legitimate market makers a bad name but says global regulatory developments are progressively making it more difficult for such businesses to thrive.
Hard data on the extent of wash trading is difficult to come by. Bitwise famously reported in 2019 that 95% of the volume on unregulated exchanges was fake. A more recent study by the National Bureau of Economic Research (NBER) in December 2022 found that the figure had eased to around 70%.
Yang Yang, a co-author of the NBER study, tells Magazine that properly regulated exchanges accounted for less than 3% of spot market transactions, according to the research.
Regulated exchanges, as defined under New York’s crypto BitLicense, comply with stringent requirements around Anti-Money Laundering programs and customer information record-keeping, and they have a disaster recovery system.
Since BitLicense debuted in New York, other financial hubs around the world — such as Singapore, Hong Kong and Dubai — have enforced strict licensing requirements of their own.
“In an unregulated exchange, you can immediately spot that their economic indicators are so far away from the regulated market,” Yang says.
And that’s where the illicit market makers ply their dark trade.
Market makers and liquidity provision
It’s important to differentiate between the two main types of market makers. Exchange market makers focus on creating a stable, liquid trading environment for a particular cryptocurrency exchange.
Token market makers, by contrast, are often engaged by the issuers of the tokens themselves. Their primary objective is to ensure liquidity for a specific token, particularly in its early stages or during periods of low trading volume.
This type of market-making can help newer tokens gain traction and visibility in a crowded market.
But what some token projects hope to get from market makers and what the legitimate firms provide are often at odds.
“Generally, what [token projects] look for is they think that a market maker is there to create volume, increase price and do pump and dumps,” Jelle Buth, co-founder of market maker Enflux, tells Magazine.
“But that is completely incorrect.”
He explains that a market maker’s role is to make assets tradable by providing liquidity and maintaining a healthy order book, which contains all the buy and sell orders for an asset.
By placing orders on both sides of the book, they ensure that there’s always a match available for incoming orders, which enhances the asset’s liquidity.
Market makers offer to buy (bid) and sell (ask) a crypto asset at different prices. The difference between these two prices is known as the spread.
A narrower spread generally indicates a more liquid market, whereas a wider spread suggests less liquidity and higher trading costs.
“It’s a market maker’s role to make this as tight as possible, while of course keeping in mind it not being a largely loss-making activity.”
A narrow bid-ask spread is often accompanied by solid market depth, which refers to the available quantity of buy and sell orders at different price levels within an order book at a given moment.
Market depth can also gauge an asset’s ability to absorb large orders without significant price shifts.
A market maker is expected to maintain liquidity without compromising profits.
According to Buth, there are two primary business models for token projects: the service model, where market makers receive set payments for creating a liquid trading environment, and the loan option model.
In a loan option model, a market maker borrows a certain amount of tokens from a crypto project with an agreement the tokens are initially priced at a set rate. These tokens are used to provide liquidity but often come with a primary goal of turning a profit, Buth says.
Market manipulation and loan option incentives
For instance, consider a market maker that borrows 100,000 tokens from a cryptocurrency project at $1 per token.
This isn’t just a straightforward loan. It comes with a built-in option for the market maker to settle the loan at the end of an agreed period by returning an equivalent number of tokens at the same price of $1 each, regardless of the current market price.
During the loan period, the market maker sells these tokens in the open market to provide liquidity, potentially profiting if the token price rises.
Ideally, the market maker would have retained the proceeds from selling the tokens at higher market prices during the loan period.
At the end of the loan period, they can use some of these proceeds to buy back the tokens at the current market price if needed, or they might already have the tokens available to return. They can then settle the loan at $1 per token, which can be profitable if the repurchase price is less than the sale price during the loan period.
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This allows them to cover their obligation while potentially making a profit. It also allows the market maker to manage their risk by knowing in advance the maximum price they will need to pay to return the borrowed tokens, while the token issuer benefits from the liquidity and market presence during the loan period.
The downside of the loan option for projects is the lack of control over their own tokens. Buth says:
“I’m not saying they always do, but there is an incentive for them to trade unethically [and] manipulate markets in order to reap the most profits, rather than there being an incentive to create a healthy market or trading environment.”
According to Buth, market makers under the token loan model may even artificially suppress the price of a token before the agreement expires, aiming to renew the partnership at a lower price.
“The moment the agreement is renewed, they allow the price to go up significantly,” Buth adds.
The “unethical” market makers
The operator of one of the less salubrious market-making firms, who wishes to remain anonymous — let’s call them MM — says that exchanges have incentivized the use of unethical market makers.
“Exchanges have unspoken requirements where the project must exceed a certain amount of daily trading volume, and this creates an incentive for projects to inflate their trading volumes,” according to MM.
MM says token projects approach their services to list on exchanges, whether that be on decentralized or centralized platforms.
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The source declines to elaborate on how a listing is achieved but says their market maker does things “competitors don’t.”
According to screenshots of documents seen by Magazine, some of the services MM offers, or offered, include unethical and potentially illegal tactics to boost price and volume, such as front-running news events and wash trading.
This is “clearly unethical,” Beke of Kairon Labs says of the tactics, and he refuses to call businesses that provide such services “market makers.”
“This, in the long run, will only hurt investors and traders because they are caught up in these volatile moves,” says Beke, adding that potential clients are often disappointed when his firm doesn’t offer volume and price-pumping services.
Exchanges crack down on shadowy crypto market makers
Asal Alizade, head of operations at Web3 consulting firm Blocklogica, confirms MM’s contention that trading volume is one of the most important factors for projects to get listed on centralized exchanges. However, exchanges are also on the lookout for manipulation.
“In top-tier exchanges, if the project doesn’t maintain the requirements and can’t fulfill the minimum trading volume for a specific period, or doesn’t meet the terms and conditions of that exchange and shows unethical practices such as pumping and dumping the token, or manipulating the price, the token will be delisted,” Alizade tells Magazine.
“Top-tier exchanges will not only check the legal documents of the token, including licenses and legal opinion but also check the organic community of the project and evaluate the strength of this community, including the project’s social channels,” she adds.
The exchanges Magazine speaks with outline proactive steps they take to weed out bad actors.
“The crypto ecosystem is highly competitive, and it’s not uncommon for participants to fabricate data to stay ahead of the curve,” Ryan Lee, chief analyst of Bitget Research, tells Magazine.
“On Bitget, the trading volumes are real, including transactions from retail traders, institutional clients and market makers. One of our predominant strategies to prevent wash trading is an updated platform algorithm that strikes out any form of price indifference,” Lee says.
Vivien Lin, chief product officer of crypto exchange BingX, tells Magazine that crypto platforms are deploying better monitoring systems to identify and mitigate suspicious trading as a result of more regulated entities joining the market.
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“At BingX, we’ve heightened rule enforcement and introduced strict penalties for breaches, in addition to enhancing clearing and settlement processes to combat wash trades,” Lin says.
Bitget declined to comment when asked if exchanges have listing fees or penalties for projects that fail to maintain a certain level of trading volume. BingX says it does not charge listing fees or impose volume requirements.
For ordinary users, it’s difficult to determine the extent of wash trading at any given time. CoinGecko CEO Bobby Ong tells Magazine that the aggregator does not have its own internal mechanism to filter out wash-traded volume. CoinMarketCap did not respond.
Regulations may curb wash trading and other dark practices
The European Union has introduced its Markets in Crypto-Assets regulatory framework, which was published on June 9, 2023, in the Official Journal of the European Union and took effect 20 days later. Full compliance is required by Dec. 30, 2024.
MiCA prohibits behaviors considered market manipulation, including conducting transactions that give false or misleading signals about a crypto asset’s supply, demand or price. Wash trading falls under this definition.
“No one can advertise this due to regulations like MiCA,” MM says. “Most market makers are regulated now, so you will start seeing less and less of [unethical services], but there are bad actors out there that will always be willing to do anything a client asks for.”
Buth of Enflux believes that dodgy market makers will simply move offshore.
“I think that regulation is for sure good, [and] it should move there, but I still think there are always ways as long as there’s demand for unethical practices,” Buth says.
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Yohan Yun
Yohan Yun is a multimedia journalist covering blockchain since 2017. He has contributed to crypto media outlet Forkast as an editor and has covered Asian tech stories as an assistant reporter for Bloomberg BNA and Forbes. He spends his free time cooking, and experimenting with new recipes.
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