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Apr 15, 2025

Deep Dive

The Founder’s Guide to CEX and DEX Market Makers

@dreamsofdefi

TL;DR Market makers are pillars of the crypto ecosystem because every team needs deep liquidity at all times. But while the crypto market maker complex serves many teams, it’s widely misunderstood today. Founders should learn market makers’ business models and incentives, the costs and risks, and how onchain liquidity differs to ensure their token’s survival.

One of the biggest trends of this crypto cycle has been the space’s growing hostility towards market makers. The crypto market maker complex is widely viewed as a mysterious world. But in recent years, market participants have become more cognizant of predatory market making practices, shifting perceptions of how market makers as a whole serve the industry.

Despite this negative attention, market makers play a crucial role in ensuring markets function and the top firms are principled actors. Moreover, while bad practices persist in certain corners, signs suggest that the crypto market maker complex is shedding its “Wild West” roots.

When launching a token, projects rely on these firms to make markets. Projects need market makers because liquidity depth is the essential foundation to an efficient market environment. It’s the key to stability, price discovery, and market confidence; weak liquidity conditions lead to weak volumes and prices, which encourages users to trade elsewhere.

Traditional market makers aim to provide liquidity on the buy and sell side and profit from the spread. They provide this service in exchange for incentives but their goal is to remain market neutral. There are costs and risks to using market makers and we unpack them below to help any founder launching a token.

DEX token launches present their own unique challenges. As we uncover in this feature, onchain market making has fundamental differences to CEX market making, creating new considerations for projects.

How market makers are incentivized to provide liquidity
Why traditional market makers favor CEXs today
The challenges of market making on DEXs
The hidden risks: Mercenary dumping and other predatory tactics
How projects can evaluate their market maker

How market makers are incentivized to provide liquidity

Founders face a challenge when electing market makers: They must incentivize them to make markets in the first place. Market makers use two primary models. A key difference between them is whether the market maker or the project provides the quote asset. They are referred to as follows:

Loan and Option Model (Market Maker Owned Liquidity)
Retainer Model (Project Owned Liquidity)

With both models, a tension exists because the market maker is expected to provide liquidity depth but they’re incentivized to do the bare minimum. Setting KPIs with liquidity depth stipulations can help reduce this tension (we elaborate on this point in section 5).

The Loan and Option Model

The Loan and Option Model is the dominant model for CEX liquidity. The project gives the market maker a “loan” for their token with the “option” to buy the tokens at a strike price, which theoretically aligns incentives for project growth.

Where traders usually have to buy options to hedge their positions, the market maker receives them for free in exchange for their services. The market maker will usually try to negotiate the lowest strike price possible as lower strikes require less buy pressure over the loan duration to come into the money.

But from the project’s perspective, setting strikes at prices they would start to diversify at (rather than low prices) makes the most sense. Most market makers use the Black-Scholes model to price options and they often look at the volatility of similar tokens.

Market makers know the value of options better than the projects do.

Market makers benefit from information asymmetry. The Loan and Option Model benefits them because they get the options for free and they usually know how to price them better than the project.

Nonetheless, the market maker takes on the risk burden with this model because they own the liquidity and have a loan to pay at the end of the agreement. Their risk is lower when the strike price is lower. If the token’s starting price is $1, the ideal scenario for the market maker is to hold options with a strike price of $1 or lower. This is because a $1 strike would allow them to dump 50% of their loan as a short and bring their options in the money. By placing full-range liquidity, they can then accumulate if the price decreases or exercise the options if it increases and win in both cases.

Leading market makers do not aim to profit from long-term price changes. Their goal is to minimize risk.

In practice, the options rarely get exercised (the market maker tooling platform Forgd estimates that the redemption rate is ~10%); the market maker may expect to profit from options in some cases, but they mostly profit from collecting a share of the bid-ask spread from the overall trading volume. The leading market makers aim to stay delta-neutral and profit from providing liquidity for many tokens with high volumes—not from the tokens rising in price. This is why FUD leveled at firms like Wintermute is misguided; the top players aim to profit from servicing high volumes and capturing spreads rather than long-term price changes and their goal is to minimize risk.

The size of the typical loan has increased as the crypto market maker complex has evolved, with many lending out between 2 and 5% of their token supply today. Unlike the Retainer Model, the project does not provide any stablecoins with this arrangement—something that may appeal to teams that want to preserve their treasury (but this also means that the market maker could dump the tokens for sell-side liquidity and the project has no downside protection). Founders should note that while the market maker takes on the risk with this model, they can do what they like with the loan—and their activities aren’t always transparent.

The Retainer Model

The Retainer Model has different requirements. It serves founders looking to optimize their Project Owned Liquidity. The project must pay a “retainer” fee and commit their own token and stablecoins (meaning they carry the risk burden). The market maker’s main compensation is the retainer, though they may also receive a share of any profits on the capital, which theoretically aligns incentives.

Some projects favor this model because they perceive it as less risky than issuing a loan, but they must provide capital for both sides of the market or be open to bootstrapping the other side of the market in exchange for sub-optimal depths during the bootstrapping period. Moreover, retainer deals are usually longer-term arrangements, which can lock projects into an unfavorable deal if market conditions change unexpectedly.

A subcategory of the Retainer Model is the Self-Service Market Making Model. Smaller projects usually take this approach to manage their Project Owned Liquidity independently. They pay the market maker a monthly SaaS fee or integration fee and use their trading algorithms to deploy strategies and make markets autonomously. This approach eliminates the need for paying retainer fees and options, which may appeal to teams with limited capital. But it requires active monitoring and many projects lack the time and acumen required to execute this approach effectively. Moreover, managing liquidity independently carries potential regulatory risk because it could be perceived as trading one’s own asset.

In summary, minimizing risk is a top priority for market makers. Every market making arrangement has costs and trade-offs because market makers need to be incentivized. Founders should consider their resources and goals before committing to a model.

Why traditional market makers favor CEXs today

Most traditional market makers use the Loan and Option Model. This is the standard blueprint with which they’re incentivized, but on a fundamental level, the top firms profit from doing the following:

Continuously providing bid and ask quotes (and making a small return on capturing the spread) around their current fair price estimate
Facilitating high volumes
Maximizing capital efficiency while operating on thin margins
Discriminating toxic flow and capitalizing on uninformed flow
Remaining delta-neutral and diversifying across many tokens
Beating their competition

The top firms in the market win because they provide bid-ask quotes consistently for many different tokens. They make these quotes based on their fair price estimate, using advanced models to identify it ahead of their competition.

How market makers hedge risk

While the business model is set up in a way that offers market makers upside if a token outperforms, their focus is on servicing high volumes and managing risk by staying delta-neutral. They maintain neutrality by hedging their positions. Their strategies may include:

Options (usually offered as part of the deal)
Perps
Maker orders
OTC sales

Options allow market makers to remain delta-neutral even if the asset has no other derivative instruments like perps available. By staying delta-neutral, they do not need the price to increase or decrease. Contrary to what certain CT pundits may say, firms like Wintermute are not dumping bandits just because they make the market and the price goes down.

Firms like Wintermute are not dumping bandits just because they make the market and the price goes down.

Trading venues like Binance and Hyperliquid are increasingly listing perps at or before the TGE phase, allowing market makers to hedge risk early on. But even if there are no perps or options market for the asset, the market maker often goes short on the token through maker orders or OTC sales.

Founders should bear in mind that market makers may short their token one way or another to stay delta-neutral. This is because managing their risk is their top priority.

How market makers carve out profits on CEXs

Traditional market makers most frequently provide liquidity to CEXs rather than DEXs today. CEXs like Binance use CLOBs and there are several reasons market makers gravitate towards them:

High volumes and liquidity
Fast speed, offering the ability to respond to changing conditions quickly
CLOB architecture, allowing for full control of the bid-ask spread
Ground zero for price discovery
USD-paired pools
Less transparency (and visibility) than DEXs
Less toxic flow than DEXs
Existing relationships with CEXs, which often results in special benefits

Though the gap is narrowing, CEX volumes are greater than DEX volumes today and price discovery for most projects happens on centralized trading venues (the memecoin boom notwithstanding).

Market makers can more easily conceal their activities on CEXs.

Market makers need to be capital-efficient to maintain profitability and CEXs offer a more favorable path to achieving this goal due to their speed and liquidity advantages. This is especially true for firms that receive benefits from CEXs they work closely with. For example, leading market makers with a proven track record often receive discounts on order fees and reduced margin requirements. They do not receive any such benefits on permissionless DEXs.

They can also more easily control the bid-ask spread and conceal their activities on CLOB-based CEXs. While everyone can see orders on the CLOB, it’s not clear who placed them. This helps market makers preserve their edge.

As one leading market making firm put it: “If we receive a 1% allocation [of a token’s supply], we’ll put as much as the project allows us to on CEXs [and as little as we can on DEXs] because that’s where we’re most profitable.”

In summary, market makers operate on CEXs today because they are in the business of catering to high volumes and providing tight spreads at speed. CEXs also give market makers more control over the spread and discretion. They may also offer special benefits.

The challenges of market making on DEXs

While traditional market makers also service onchain pools, they face a number of hurdles. Not only are DEXs the secondary trading venue for most assets, the pools are often paired in a volatile asset like ETH or SOL, which creates more risk for the market maker than providing stablecoins. DEXs also update slower, which makes setting tight spreads difficult and creates significant IL and MEV risk. Gas costs can also become prohibitive with strategies that require frequent updates.

Moreover, onchain pools are more transparent than CEXs. Where CEX orders are anonymous, it’s harder for market makers to keep their operations private onchain because account addresses are traceable. If one address linked to a market maker removes liquidity, arbitrageurs could try to game them and their competitors could follow suit. Exposing alpha is -EV in a business where identifying the fair price and providing tight spreads is key and the winner takes most.

Market makers face IL and MEV risk in onchain pools. They must also factor for gas costs and frontrunning.

Traditional market makers do not set the spread in onchain pools but DEX traders effectively pay one through the pool fee. On UniV3, this “spread” ranges from 1 to 100 basis points (0.01-1%) while UniV4 has customizable fees.

Market makers target tokens with high volumes, primarily profiting from uninformed flow. DEXs have a higher proportion of toxic flow than CEXs, which impacts the market makers’ profitability. Market makers aim to find the fair price ahead of the market and continuously carve out small profits but this gets harder when sophisticated arbitrage bots are rebalancing pools.

How DeFi innovations could bring more market makers onchain

Though CEX market making is the top firms’ bread and butter and centralized venues carry less risk from the market maker’s perspective, the DEX landscape is evolving. As block times get faster and gas fees decline, the risks and costs of doing a good job making markets onchain are declining. UniV4 Hooks will likely transform onchain market making by increasing competition between pools. In this environment, traders could seek out pools with lowest fees.

These developments are happening as DEX volumes rise against CEXs and the market increasingly calls for more transparency—suggesting that there will be ongoing demand for onchain market makers in the future.

In summary, onchain market making is a new idea that makes less sense for traditional firms today. But it’s likely to gain more attention as onchain UX improves and volumes rise.

The hidden risks: Mercenary dumping and other predatory tactics

Market makers are supposed to be neutral actors. But projects can put themselves at risk when they engage with the wrong firms. Founders should be aware that the space’s opacity helps bad actors extract value.

How predatory firms can rekt projects with shorts and options

In the worst cases, market makers use the loan and option model to short the project’s token. This predatory strategy sees market makers aggressively dump the token for quote-side liquidity in expectation of downward price action. Later, they buy the tokens back at a discount post-TGE to cover their loan. The market maker can use this strategy with minimal risk because the options act as a hedge against their short position.

Why low floats and mercenary actors are a lethal cocktail for your project

As Infinex and Synthetix founder Kain Warwick recently explained in a viral X thread and Unchained podcast on predatory market maker practices, the shorting strategy is especially lucrative with low float/high FDV tokens. The most predatory firms will dump the token, use low liquidity to pump it and exercise their options, then dump it again. Projects are always at greater risk when the float is low because a lower circulating supply gives the market maker more power to move the market.

“Painting the charts” to minimize risk

Some market makers use the “painting the chart” strategy to curtail their risk and avoid making the market. With this approach, the firm “paints” orders on CEXs to lure other market makers in and then cancels their bid. This means they can preserve their capital without committing to the job they agreed to do because they trick other firms into providing liquidity. The opaque nature of market making in crypto makes this strategy possible.

The “kickback and exit” strategy: A new extractive meta that harms retail

The latest evolution in the crypto market maker complex is the advent of so-called “exit strategy” services that offer projects a way to strategically dump their tokens on retail.

Some projects have opted to offer liquid funds discounted tokens as a kickback on the proviso that they agree to bid on the TGE, which creates a scam pump. Then, they transfer a portion of the supply to the market maker to dump on users.

Though these conversations happen behind closed doors, this meta has been an open secret in crypto circles this year. It’s particularly harmful to retail but founders should also take extra care to avoid any firms that offer any hint of “exit strategy” services.

Could Binance’s clampdown signal a brighter future?

As more voices have exposed nefarious market making practices, Binance has started to take action, recently banning one firm for offering “exit strategy” style services. The top CEX has a significant influence on the market due to its dominance; it proved this when it stipulated public unlock schedules for listings and shared proof of reserves post-FTX before they became the norm.

This latest move to ban a predatory market maker hints that the bad practices that have sullied this space’s reputation could soon see a decline. Nonetheless, founders must not neglect due diligence when choosing a firm for their liquidity needs.

In short, projects can put themselves at risk if they engage with the wrong market maker. Though the leading firms act with integrity and the industry is beginning to stamp out bad practices, founders must take caution when choosing any market making service.

How projects can evaluate their market maker

Traditional market makers often receive criticism for using information asymmetry and operating in an opaque manner. For any founder preparing to engage with a market maker, setting evaluation metrics that increase transparency and shed light on the market maker’s operations is key.

Projects usually set KPIs and regular reporting requirements in contracts to ensure their market maker fulfills their obligations. These KPIs usually cover liquidity depths, spreads, and uptime. Moreover, contracts frequently feature an exit clause allowing the project to cancel the agreement and claw back the loan if they are unhappy with the market maker’s performance.

Setting evaluation metrics that shed light on the market maker’s operations is key.

But enforcing and tracking these KPIs is challenging. Market maker proposals do not have standardized KPIs and contracts vary widely between firms. Moreover, their opacity makes keeping track of operations difficult.

Bringing more transparency to the market maker complex

Tooling platforms with additional advisory offerings like Forgd, GlassMarkets, and Coinwatch offer founders a way to evaluate their market maker’s performance. These services provide insights and real-time liquidity tracking, bringing more transparency to how market makers operate (and whether they’re meeting their KPIs).

In an Emergence 2024 keynote address, Wintermute CEO Evgeny Gaevoy discussed the opacity of market making while calling for more transparency across the industry. Gaevoy argued that normalizing disclosures would make the industry healthier, suggesting that projects could disclose market maker agreement details (including the duration and option strike price) and market makers could disclose any misrepresentation on the project’s side.

In short, projects should set KPIs and ask for reports to ensure their market makers are providing sufficient depths and tight spreads. Using liquidity tracking services is also a good idea because measuring KPIs can be difficult.

Find the Right Market Maker for Your Project

To sum up, every project needs a market maker because they need deep liquidity for their token. Projects are more likely to suffer from weak volumes, sentiment, and price action if they do not achieve sufficient depths.

When engaging with a market maker, projects can usually expect to sign a Loan and Option (Market Maker Owned Liquidity) or Retainer (Project Owned Liquidity) deal. Understanding how they work and the trade-offs for each model is important—Loan and Option deals can leave projects exposed to dumping while Retainer deals require a stablecoin commitment in addition to the token and fees.

Most traditional market makers favor CEXs today because they offer significant speed and liquidity benefits. Though the landscape is changing, market making on DEXs with either a Loan and Option or Retainer deal makes less sense for the leading firms. Due to the way the deals are arranged and the opaque nature of their operations, there are risks to engaging with any market maker, so establishing KPI and reporting practices is key.

But projects should also address their onchain liquidity as a top priority because liquidity strength is vital across both CEXs and DEXs. Learn how Arrakis Pro has helped 50+ teams optimize their liquidity across DEXs in our in-depth guide to POL or fill out our onboarding form to find out how we can help you.