FTX and Alameda Research Collapse in Sad but ‘Good for the Long-Term’ Event, Says DWF Labs Managing Partner – Bitcoin News Interview

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While the collapse of crypto exchange FTX and its subsidiary Alameda Research would have left many crypto players, including market makers, in the worst possible position, according to Andrei Grachev, managing partner at DWF Labs, this incident may have helped ‘flush out businesses that were not sustainable enough to operate during a storm. As a result, the ‘market will be healthier’ going forward.

The art of market making

In addition to weeding out weak players, Andrei Grachev suggested in a written response to questions from Bitcoin.com News that the collapse of key crypto industry players like FTX and Terra underscored the importance of adopt measures that protect users. One such measure, which can be used by global digital asset market makers like DWF Labs, is the so-called pump and dump protection system. The system is basically a liquidity management technique on exchanges.

Meanwhile, Grachev also shared his perspective on topics ranging from the misconception about market makers to how market making differs between centralized exchanges (CEX) and decentralized exchanges. Below are the managing partner’s answers to the rest of Bitcoin.com News’ questions.

Bitcoin.com News (BCN): Can you briefly define market making as well as what happens when a user buys a crypto asset on a centralized exchange or sells it on a decentralized exchange?

Andrei Grachev (AG): A market maker creates liquid markets, quotes order books (puts buy and sell limit orders into order books) and maintains the spread. Simply put, market makers create tradable markets. [Decentralized exchanges] DEXs (especially automated market makers) are a bit more limited in terms of market making tools, but even here – a market maker maintains a sufficient level of liquidity on AMM [automated market maker] consolidates and performs additional work in order to maintain the same price level on centralized and decentralized exchanges.

Since market makers make money by allocating bid and ask prices, based on a given proposition, the market maker [for instance] sell a token on Coinbase a few [basis] points (bps) higher than on a DEX and sell a token on the DEX a few bps cheaper than on Coinbase.

BCN: What do you think is the common misconception about market making?

AG: It’s very close to a conspiracy theory: while a token goes up, the market maker pumps; while a token is falling, the market maker is dumping. You know that situation where you bought something and it fell apart instantly? The same. A market maker has reviewed your position and traded against you.

The reality is completely different – a market maker maintains liquidity on both sides (buy and sell) and maintains a tight spread. The more advanced can also take limit orders from an order book to improve the market and increase organic volumes.

BCN: Does market making differ between decentralized exchanges and centralized exchanges?

AG: I would split it a bit differently – based on order book (it could be CEX and DEX) and others (only DEXs. This includes MAs on DEXs and liquidity focused on Uniswap V3 ).

Book-based trading allows market makers to use different types of orders (limit, immediate or cancelled, market, etc.) in order to create a market and provide or remove liquidity from the books.

AMMs are much less flexible because transactions take place in pools of liquidity. The biggest challenge for AMMs is maintaining the same price on DEXs as their centralized counterparts by adding or removing liquidity as needed. They also constantly monitor large and predatory exchanges to mitigate their impact.

Concentrated liquidity is similar to MA, but it allows traders and market makers to decide on a price range for the supply of liquidity. It gives much more flexibility compared to AMM, but it is still less flexible than order book based platforms.

Since advanced market makers use their proprietary systems for trading, most of them, including DWF Labs, interact with DEXs through a virtual order book that is emulated based on blockchain transactions and the state of AMM and concentrated liquidity pools.

BCN: How has the collapse of FTX and Alameda Research affected market makers and how is the market handling the crypto liquidity crisis? Also, are whales now afraid to trade large volumes?

AG: First of all, all the proper market makers had funds on FTX because there was no avoiding trading on the second largest exchange in the crypto world. Some of them were badly hit and collapsed. Many others are currently going through a difficult financial situation.

In general, it is a very sad event, but it is good for the long term. The market drives out businesses that weren’t durable enough to operate during a storm. As a result, the market will be healthier.

In terms of whales and trading volumes, we are seeing a lot of activity in the over-the-counter (OTC) market, as trading liquidity has decreased significantly since the crash. For example, the same tokens that only saw [a] A 10-12% price drop after a $500,000 sell order won’t even be able to absorb a $100,000 sell order now without prices falling 60-70%.

Fortunately, the market is recovering. We started to see this positive momentum since early January 2023.

BCN: There is this notion among some project founders that liquidity is not a function of the market but of marketing. In fact, some founders believe that ensuring there are enough buyers for sellers of their tokens is enough to solve their liquidity issues. How correct are these statements?

AG: It’s true and not true simultaneously. Without marketing, liquidity is somehow inactive and artificial. If no one trades or trades infrequently, this would incentivize a market maker to predict price spreads correctly and he should increase the spread in order to maintain an acceptable level of risk. This could lead to a death spiral – the gap gets worse and trading volume decreases further, resulting in an even worse gap.

In another scenario, let’s say a project relies entirely on organic traders. It’s possible – Bitcoin started without any market maker and that was good. But it can be hard to repeat that success.

Traders go to the market and have a wide range of tokens available for trading. If we are talking about a token in development, it would probably have a weak market structure, even with good marketing. Why? Because compared to market makers, organic traders trade according to their own vision rather than according to quantitative models. This makes spreads wider and execution speed slower because retail orders must match each other, instead of being bought and sold instantly by a market maker. For example, DWF Labs has a market share of 40-70% of trading volumes for many tokens and in case if we remove our setups from these markets the volumes would crash.

BCN: Some players in the market have incorporated what is called pump and dump protection. Can you briefly explain what it is and how market makers use it to ensure that participants are safe in the event of extreme price volatility?

AG: If we exclude the really dramatic events like the stock market crashes of FTX or Terra LUNA when the selling pressure was insane and no one could help, we would see market makers dampening price actions through liquidity management on scholarships. In 99% of cases, pumping or dumping is executed on a particular exchange and then extended to other locations like a scourge. If not so drastic, the curse could be avoided by fixing the price on the particular exchange. If that doesn’t work, market makers let price discovery happen organically and maintain relevant market depth around the spread.

BCN: At first glance, market making resembles the smartphone industry, where the products offered are seemingly indistinguishable. How then do market makers differentiate themselves from the competition?

AG: [The] Gone are the days when market makers could offer a simple bot to build up an order book. Market makers play an important role in the markets. We are not visible, but without us the market would be much less efficient and spreads would be much wider.

I also believe that a true market maker is also a partner, advisor and sometimes even an investor who can leverage their knowledge and relationships with exchanges, funds and holding companies to move the project forward and let it grow. DWF Labs builds relationships with projects only in this way, acting not only as a market maker but also as a partner. Like you said, it’s like the smartphone industry, but there’s only one Apple, even in the smartphone industry.

BCN: It is often said that many projects are reluctant to launch their tokens in a bear market. Is this true (and if so, does it make sense)?

AG: There are two sides to every coin. During a bull market, a project could rise to a massive valuation, be listed on a stock exchange with a large market cap, and be pumped further by the market. Most of these projects collapse once the market turns bearish. It is difficult to survive and meet investors’ expectations, especially when the reality on the ground is far behind.

Compared to bull markets, bear markets have a certain beauty. Yeah, it’s true that it’s more complicated to raise funds and the valuation is generally smaller. But when a project goes public with a small capitalization, it is very likely to be pushed by the market and then stabilized. Then, since the project went into the market when everything was selling at depressed valuations, the market can only reverse into bullish mode – which will push the project higher and give it additional chances to succeed.

What are your thoughts on this story? Let us know what you think in the comments section below.

Terence Zimwara

Terence Zimwara is an award-winning journalist, author and writer in Zimbabwe. He has written extensively on the economic issues of some African countries as well as how digital currencies can provide an escape route for Africans.

Image credits: Shutterstock, Pixabay, Wiki Commons

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