How to make a market in cryptocurrency? Sharing of cryptocurrency market-making strategies

Market makers in crypto provide liquidity by placing buy/sell orders around the market price, profiting from bid-ask spreads while reducing slippage and enhancing order book depth.

Jun 13, 2025 at 08:43 pm

Understanding the Concept of Market Making in Cryptocurrency

Market making in cryptocurrency involves providing liquidity to trading pairs on exchanges by placing both buy and sell orders around the current market price. The goal is to profit from the bid-ask spread while ensuring that there's enough volume for other traders to execute their trades efficiently. In decentralized and centralized crypto markets, market makers play a crucial role in maintaining order book depth and reducing slippage.

Unlike traditional finance, cryptocurrency markets often lack institutional-level liquidity due to their relatively young nature and fragmented exchange ecosystem. This makes market-making strategies even more critical for traders or firms looking to generate consistent returns without directional exposure to price movements.

Key Point: A successful market maker profits from frequent small gains rather than large directional moves.

---

Setting Up Infrastructure for Crypto Market Making

To begin with market making in the crypto space, you need robust technical infrastructure. This includes:

• Exchange API access: You must connect to multiple exchanges via APIs to place and cancel orders rapidly.
• Low-latency servers: Hosting your trading bot on a server close to the exchange’s data center improves execution speed.
• Risk management tools: Implement systems to monitor and control open positions, volatility, and potential losses.
• Trading algorithms: Develop or deploy existing bots capable of placing limit orders based on real-time market conditions.

It's important to test your system in a sandbox environment before deploying it with real funds. Many exchanges offer demo or testnet APIs for this purpose.

Important Tip: Always use a dedicated wallet address for each exchange connection to avoid fund mix-ups and enhance security.

---

Choosing the Right Trading Pair for Market Making

Not all trading pairs are suitable for market making. You should focus on pairs that exhibit certain characteristics:

• High trading volume: More volume means more opportunities to capture spreads.
• Moderate volatility: Excessive volatility increases risk, but too little reduces profit potential.
• Liquidity gaps: Look for pairs where the bid-ask spread is wider than average, offering room for arbitrage and spread capture.

For example, BTC/USDT or ETH/USDT on major exchanges like Binance or Kraken are popular choices. However, newer altcoin pairs may also present lucrative opportunities if monitored carefully.

Critical Insight: Avoid highly illiquid or pump-and-dump-prone pairs unless you have strong risk controls in place.

---

Designing Your Market-Making Strategy Algorithm

A well-designed algorithm is essential for effective market making. Here are the core components of such a strategy:

• Order placement logic: Determine how far away from the mid-price you’ll place your buy and sell orders.
• Order size determination: Decide whether to use fixed sizes or dynamic sizing based on available liquidity.
• Inventory management: Adjust your position based on your current holdings to avoid overexposure to one side.
• Cancellation mechanism: Cancel stale orders when they no longer align with current market dynamics.

One common approach is the Avellaneda-Stoikov model, which uses stochastic calculus to optimize bid-ask quotes based on volatility and inventory levels. While complex, this model can be simplified for practical use in crypto environments.

Technical Note: Use time-weighted average price (TWAP) or volume-weighted average price (VWAP) as benchmarks for adjusting your quotes dynamically.

---

Risk Management and Monitoring in Real-Time

Market making is inherently risky due to directional exposure, especially during volatile periods. To mitigate these risks:

• Set stop-loss limits: Define thresholds at which your bot will stop quoting or reduce exposure.
• Use hedging mechanisms: Consider hedging with futures or options if available on the asset you're quoting.
• Monitor inventory imbalance: If your sell orders get filled more than buy orders, adjust your quote prices accordingly.
• Track exchange outages: Be prepared to pause operations during exchange downtime or extreme volatility events.

Real-time dashboards can help visualize metrics like spread capture, net profit per hour, and inventory levels across multiple exchanges simultaneously.

Pro Tip: Use alerts via email or SMS to stay informed about abnormal behavior or sudden changes in market conditions.

---

Frequently Asked Questions (FAQs)

Q: Can I start market making with a small capital?

Yes, but your impact and profitability will be limited. Small accounts may struggle to cover fees and maintain competitive spreads. Start with low-risk pairs and gradually scale up.

Q: Do I need programming skills to become a market maker in crypto?

While not mandatory, having programming knowledge helps significantly. Most serious market-making operations use custom-built bots or modify open-source ones like Hummingbot or Gekko.

Q: What are the tax implications of market-making activities in crypto?

Tax treatment varies by jurisdiction. In many countries, market-making profits are treated as trading income, which may be taxed differently than long-term capital gains. Consult a tax professional familiar with crypto regulations in your region.

Q: How do I handle regulatory compliance when market making in crypto?

Regulatory frameworks are still evolving. Ensure that you comply with local laws regarding automated trading, anti-money laundering (AML), and know-your-customer (KYC) requirements. Some jurisdictions require licensing for market-making activities.