The liquidity in the market has been continuously drying up this year. Coinbase revealed in its Q3 financial report that the withdrawal of market makers has led to a loss in trading volume. BlackRock is seeking potential cooperation with top market makers such as Jane Street and Jump Trading, which has sparked confidence in the market’s recovery among the public.
Recently, there have been reports that BlackRock is seeking potential cooperation with top market makers such as Jane Street and Jump Trading, with the hope of assisting BlackRock in market-making after the approval of Bitcoin spot ETF. The potential cooperation between market makers and BlackRock has once again sparked confidence in the market’s recovery. Especially since the bankruptcy of FTX last year and the closure of crypto banks Signiture and Silvergate this year, the liquidity in the market has been continuously drying up.
Since the launch of the regulatory investigation into cryptocurrencies in June, the market has become increasingly fragile. More people are pointing to the uncertainty of regulations as the reason for market makers such as Jump Trading and Jane Street gradually exiting the cryptocurrency market, resulting in a liquidity crisis. Industry giant Coinbase also revealed in its latest financial report that the withdrawal of market makers has resulted in a significant loss in trading volume.
According to data from Kaiko, from early July to mid-August, the market depth decreased by about 15% for a 1% increase in trading volume, highlighting the importance of market makers in the market.
In a market with gradually weakening market depth, any slight movement can lead to significant price fluctuations. For example, in August, the announcement of Evergrande’s bankruptcy protection and Tesla’s liquidation of a certain amount of Bitcoin in the past quarter caused the price of BTC to drop by more than 16.7%. In October, the false news of the approval of Bitcoin spot ETF caused the entire market to surge by nearly 17%. These seemingly irrational surges or declines are mainly due to the withdrawal of market maker liquidity.
Therefore, not only BlackRock but every ETF management company will actively hire market makers to help mitigate the impact of large-scale or concentrated trading orders on ETF prices. This is particularly important for less active ETFs that may not have other investors willing to buy on a given day. Without the intervention of market makers, slippage may increase significantly, resulting in a price completion only at around 10% of the nearest market price. This could cause the price of ETF shares to drop by about 90%.
In addition to providing liquidity, market makers also play two main roles:
1. When asset prices experience significant fluctuations, market makers take countermeasures to provide stability to the ETF. For example, if a market maker provides $10M in liquidity for a digital asset, and the price of the asset rises by 10%, the market maker will hold a long position worth $8M. Although the asset may continue to rise to 8%, the market maker may start increasing sell orders and reducing buy orders when it reaches a 5% increase due to risk management considerations. This counteractive operation helps slow down the speed of price fluctuations.
2. Arbitrage allows the ETF’s value to reflect the true price of the underlying assets. Bitcoin trading is 24/7, while the US stock market’s ETFs only have sufficient liquidity during certain times. When there is a lack of liquidity, the NAV of the ETF cannot reflect the true price of BTC assets, resulting in a price difference between the ETF and the spot market. Market makers’ arbitrage activities can significantly reduce this price difference.
Market makers play a critical role not only in providing liquidity and active monitoring for ETFs but also in the creation and redemption process of ETFs, ensuring that the prices investors pay when buying or selling reflect the value of Bitcoin in the ETF.
ETFs operate primarily in the primary and secondary markets, similar to stocks. In the primary market, BlackRock first issues a large amount of Bitcoin to authorized participants (APs) as an exchange for ETF shares. After receiving the ETF unit assets (Bitcoin), authorized participants also act as market makers and allow ETF units to be traded on the secondary market. Investors can trade ETF units with market makers or other investors on the exchange on a daily basis, just like trading stocks.
Ordinary users can participate in ETF benefits by engaging with market makers through upstream industries such as custody services provided by institutions like Coinbase, Bank of New York Mellon, and Paxos. These services indirectly provide ordinary investors with safer ways to store and manage digital assets. Through investment custody service providers, ordinary users can receive benefits, such as Coinbase’s stock price rising over 8% on the day of its financial report despite a net loss in Q3.
Alternatively, ordinary users can also participate in compliance businesses provided by blockchain data companies such as OKLink, Chainalysis, and Elliptic. These businesses help financial institutions and regulatory bodies identify and track the compliance of digital assets. For example, they provide tools to verify the origin of digital assets for custodian companies or fund management companies, ensuring that funds do not violate anti-money laundering regulations and face regulatory penalties.
Ordinary users can not only participate in investments in ETFs and other upstream industries but also use tools provided by blockchain data companies, such as OKLink’s browser feature, to browse and monitor the transactions and fund flows of publicly available ETF-related wallet addresses. This allows for better observation of the fund dynamics of underlying assets, ensuring clearer understanding and participation in the digital asset market and blockchain ecosystem, and better risk management and rational investment decision-making.
In conclusion, market makers play a vital role in the cryptocurrency field. They contribute to the development and promotion of new projects while reducing transaction costs and improving efficiency. Improper behavior by some emerging market makers in the past has caused the market to have negative sentiment towards market makers, considering them as “market manipulators.” Therefore, market makers also need to comply with industry and regulatory standards to maintain their reputation and gain market and compliance support.