Ter this blog postbode wij’ll voorkant the basics of what is market making strategy, describe its pitfalls, and calculate profitability of market making on different exchanges with various cryptocurrencies. Please love.
What is market making?
Market making is a trading strategy that lets traders make money when executed with relatively stable instruments. Market makers earn their profits by providing liquidity for other traders. They do so by creating limit orders te both directions and they take the bid-ask spread spil their earned income. Let mij explain with a picture.
The idea behind the strategy is ordinary: buy low, sell high. If, let’s say, BTC is trading at $17,000 a speelpop, you create a buy order for $16,999 and a sell order for $17,001. When both orders get packed you earn $Two, the spread, for providing liquidity to other traders.
Let’s calculate relative profitability of the market making strategy. Relative profitability means wij’ll calculate it te procent, relative to the capital that you’re using te this strategy.
Suppose you want to be a market maker and you allocate $Ten,000 to this strategy. Let’s also suppose that you’re trading EOS/ETH on EtherDelta. Spil of writing this article, 1 EOS is trading for toughly $8, and EtherDelta has $0.26 bid-ask spread.
Spil you reminisce, one market maker’s trade consists of creating two orders, buy and sell, and then waiting for them to pack. So, you create a buy order for $8 and a sell order for $8.26. When they both get packed you earn $0.26.
The formula for calculating relative profitability on each trade is spread / (Two * price). Te our case, that’s 1.625% on each trade. Not bad, considering that you can keep doing the same thing overheen and overheen again and lightly get to 100 trades a day. Let’s see what happens when you do so and reinvest the profits from each trade.
Profitability on GDAX BTC/USD
For ease of calculations let’s speld BTC price to $17,700. GDAX is a fairly established exchange and, due to its centralized nature, it’s able to execute deals so quick that it consistently has the minimal $0.01 spread. Let’s see what a market maker can earn if they invest $Ten,000 into this strategy.
To waterput things ter perspective, 100 trades with $Ten,000 fund is one million dollars te volume. For providing this much liquidity to the market you’re only rewarded with about Two.Five cents. This leads mij to believe that GDAX either has some behind the scenes agreements with market makers and the exchange provides them with rebates, or that GDAX does market making themselves.
Ter brief, market making BTC/USD on GDAX is hardly worth it.
Profitability on EtherDelta EOS/USD
Decentralized exchanges, such spil EtherDelta and Radex, typically have larger spreads, which is flawless for market making. For this and the next examples wij’ll simulate earnings with a number of different spreads: 1 cent, 6 cents, 11 cents, 16 cents, 21 cents and 26 cents.
Again, for ease of calculations, wij’ll speld EOS price to $8.
Now, thesis are much better numbers! If the spread is 1 cent you’ll end up earning $644.74, or harshly 6.4%. However, if wij take the current spread of 26 cents, you’ll end up with $50,125.17 on a $Ten,000 investment!
Profitability on EtherDelta ZRX/USD
Let’s see how the picture switches when wij market make an asset with another price, such spil ZRX. Since the value of ZRX is presently $0.35 wij will not proef with out-of-this world spreads, and wij’ll take the 1 cent spread that EtherDelta presently has spil the baseline.
Wow. Even with 1 cent spread the comes back are mind deepthroating. You can lightly do a 100 trades a week and get 400% comes back if you do market making right!
Profitability on Radex ZRX/USD
Radex has a unique distinguishing factor – market makers earn 0.1% rebate on every order they create. Let’s waterput thesis numbers te perspective and compare market making on Radex against EtherDelta.
Because of the market making rebate and the compounded rente you end up earning reserve $4277.9 overheen a hundred trades, or an reserve 42% of your initial investment.
When can market making go wrong?
Market making is profitable when the underlying muziekinstrument has a relatively stable exchange rate. There are two cases when market making violates down. Again, let’s use the same BTC/USD example.
BTC goes to the moon
When BTC all of a sudden starts moving upwards, your buy order, the one that attempts to buy low, doesn’t get packed. However, your sell order will sell just fine, but at the price that you set te advance, so you’ll miss the rail to the moon.
Te this case you’ll simply fix your position te USD. You’ll miss the gains you could have had by simply holding BTC, but you’ll keep your money te dollar omschrijving.
BTC goes to $0
If BTC abruptly goes bust, spil it did ter 2013 when Mt. Gox exchange collapsed, then your sell order will never get executed because everybody is attempting to sell to someone else.
Ter this case, if your bot keeps running, you’ll end up buying all the BTC that’s available on the exchange with your dollars. Sounds pretty good ter theory, but not when BTC has zero dollar market cap.
- Market making is a fairly ordinary trading algorithm. It permits traders to earn money by exploiting market’s inefficiencies (big bid-ask spread). It also fixes this inefficiency: market making reduces the bid-ask spread making it lighter for regular traders to buy and sell, it provides liquidity for those traders too.
- Market making has its risks. If the price of the muziekinstrument you trade switches te any direction te a significant way te a brief period of time you will always end up on the losing side.
- The more efficient the exchange is, the less profitable market making becomes. However, an exchange depends on market makers providing liquidity. Ter this case most exchanges simply commence market making themselves just to keep the exchange alive. Due to this reason market makers on Radex earn 0.1% rebate on every limit order they create. The protocol itself ensures that market making will always be profitable and will keep attracting more capital, making it a better and more efficient exchange for everyone.
The code for the simulations used ter this blog postbode is available on our forum. There you can also vote for which token you’d like to get listed on Radex.