The lucrative business of market-making in crypto has faced challenges recently. Investors have become more cautious after the crypto market downturn last year, which wiped out approximately $2 trillion in value, according to a report by Bloomberg. The bankruptcy of exchanges like FTX has left digital assets stranded on collapsed platforms, making market-makers wary of future turmoil. To mitigate risks, firms have diversified their activities across multiple cryptocurrency exchanges and have stored digital assets off trading venues, using them as collateral to borrow tokens for deployment on crypto platforms. While these risk-mitigation strategies have reduced exposure, they have also eroded profit margins.
Higher cost of business
The use of intermediaries to manage collateral reduces profitability by 20% to 30% compared to leveraging coins directly with a trading platform, as reported by Bloomberg. Despite the decline in margins, market participants recognize the necessity of these strategies and acknowledge that higher costs are now inherent in the crypto market.
“The FTX debacle was a wake-up call for the industry,” said Le Shi, head of trading at Auros, a crypto-focused market-maker, in an interview with Bloomberg. “We understand that higher cost is going to be a way of doing business now.”
Market depth reveals lower liquidity
An analysis by crypto researcher Kaiko shows that the liquidity in crypto exchanges, measured by the market’s ability to absorb large orders without impacting the price, is lower now compared to the bull-run during the pandemic era. The number of trades that fall within 2% of the mid-price of Bitcoin on exchanges has decreased by more than 60% since October 2022. This reduction in liquidity is partly due to market makers leaving the space or revising their risk management strategies after the FTX incident, as well as the low volatility environment.