Market

Links to popular markets on AXO Trade, a non custodial trading platform and Decentralized Virtual Order Book Exchange settled on the Cardano Blockchain.

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About Liquidity Providing

Market making is the process of providing liquidity for assets by actively placing quotes (bids and asks) in a two sided market. Market making strategies attempt to profit by using the age old trick of buying low and selling high. Of course, the devil is in the details and it’s up to the market maker to guess what is considered “low” and what is considered “high”? Additionally, it is the market makers job to manage their capital and risk.

Reasons to Market Make:

You want to profit from assets that you hold. This could be directly through trading or indirectly by providing the liquidity necessary for the asset to appreciate in value.
General curiosity/desire to understand different facets of the ecosystem.

As I see it, the general goals of a market maker are:
a) Make profits from the spread – this requires placing bids and asks near the spot price where the action is, but if it’s too close that eats into your bottom line.
b) Manage inventory risk (the risk of holding more of an asset at exactly the wrong time) – this will be elaborated on further, but it involves.

Deploying as little capital as necessary – more capital implies more risk, but doesn’t always imply more rewards
Forecasting and adapting to market conditions
Setting stop losses
Finding flat markets and limiting exposure to runaway/parabolic markets

c) Provide the needed liquidity for an asset that you believe in.

Instances when you might consider NOT market making:
a) During runaway markets – if price goes up quickly you won’t have a chance to buy back low and if it goes down quickly you won’t have a chance to sell high. The majority of your losses will probably come during a runaway market that you had not properly planned for.
b) When it requires holding an asset that you don’t want or believe has a future. Will that shitcoin really provide the return you think? If things go bad, you could end up holding much more of it than you want.
c) In low liquidity markets – it can be more difficult to generate profits in low liquidity markets, there are some quirks of ill-formed order books that can rear their heads, and it is easier to end up lop sided with no one to sell to.

Market making can be a great way to put your assets to work for you while helping an ecosystem grow; however, there is a learning curve and there are significant risks. It's not for everyone so if you are interested then start small and work up from there.

Order Book 101

Order Types (Videos)

Before we dive into strategies, I would like to briefly go over the basics of an order book, as there are a number of features that are different from the “Automated Market Makers” (AMMs) that are prevalent in crypto.

An order book consists of orders between a pair of assets that are traded against one another. Typically the first asset within the pair is the asset that people are trying to buy or sell and the second asset is the “reference” asset that they are trading against.

If you go to Coinbase, you will see the ADA-USD pair which may look something like the following image. At the top in red are all of the “limit-like” orders from people offering to sell the first asset (in this case ADA). These are the ASK or SELL orders as they are currently “asking” a price that is somewhat above the current market value. On the bottom in green are all of the “limit-like” orders from people offering to buy the first asset. These are the BID or BUY orders as they have placed a “bid” that is somewhat below the current market value. I say “limit-like” in both cases because while they are effectively limit orders, many are automated orders (such as from market makers) that are quite frequently withdrawn and resubmitted at a different price.

All of the orders within an order book are set at different prices and for different quantities. In order to display all of this information in a digestible fashion orders are grouped into BINS of a fixed size. If the bin size is 0.1 then anything between a price of 10-10.1

If you go to Coinbase, you will see the ADA-USD pair which may look something like the following image. At the top in red are all of the “limit-like” orders from people offering to sell the first asset (in this case ADA). These are the ASK or SELL orders as they are will go within the same bin, everything between 10.1 and 10.2 will go into another bin, etc. with rules to determine where the edges between bins lie. The bin size is typically adjustable so that the user can get a coarser or finer view of the market around the spot price.

Between the ASKS and the BIDS is what’s known as the spread. The spread is the difference between the lowest ASK and the highest BID price. You may need to “zoom in” and look at a finer bin size in order to accurately see the lowest ASK and highest BID.

So then what is the current price aka the spot price? Investopedia defines it as “the current price in the marketplace at which a given asset can be bought or sold for immediate delivery.” I don’t particularly like this definition because that implies that the spot price is different for different people depending on if they are buying or selling as well as in what volume (and delivery includes fees). The thing about spot price is, it’s actually sort of undefined. That’s for the market to decide. We know it’s *somewhere* between the lowest ask and highest bid. A reasonable estimate would be to use the mid price between the lowest ASK and highest BID (and this is what the Axo protocol uses as its definition).