Understanding the Volatility in Crypto Markets
Crypto markets have long been characterized by their unpredictability. Historically, factors such as speculation, insufficient liquidity, and cycles of hype have been cited as reasons for the erratic price movements of altcoins, which are digital tokens distinct from the leading cryptocurrencies like Bitcoin, Ethereum, and Solana. However, another significant contributor to this volatility is the existence of private market-making agreements, which often play a crucial role in determining the success or failure of various tokens. Unfortunately, these agreements have resulted in more failures than victories over the years.
Wall Street’s Growing Involvement in Crypto
Recently, Wall Street firms have intensified their engagement with the cryptocurrency sector, diversifying their portfolios to include a wider array of assets, some of which are quite obscure. Notably, public companies such as MicroStrategy (MSTR) and Metaplanet (3350.T) have accrued substantial holdings, with values nearing $73 billion and $2 billion, respectively. Numerous other corporations are similarly venturing into this space. These businesses are entering a market landscape that lacks clear regulations and oversight, functioning instead through clandestine off-chain contracts. A failure to comprehend the mechanisms of crypto market-making could distort asset valuations, mislead investors, and provoke a backlash that resonates through both the Web3 ecosystem and traditional financial markets.
Inside the World of Crypto Market Making
Many people believe the volatility of altcoins stems from their lack of liquidity or weak foundational principles, which is partially accurate. However, a critical factor often overlooked is the role of market makers—entities tasked with maintaining sufficient liquidity for trading these tokens. Unlike their counterparts in traditional finance, crypto market makers operate with minimal regulatory scrutiny. Their contracts are not publicly accessible, lacking standard disclosures, audit trails, or any governing body for accountability.
Over the past decade, I have played a role in structuring and managing market-making agreements at prominent global crypto exchanges, including AscendEx and Gemini. As the leader of FBG Capital, a well-known market-making firm, I have gained insights into this complex landscape. Currently, I manage Forgd, a platform designed to assist token projects in evaluating market maker performance and negotiating more favorable terms.
The Risks of Market-Making Contracts
Many token creators are focused on building rather than trading and often lack the financial expertise to navigate the implications of these contracts or recognize the risks associated with misaligned incentives. This often results in one-sided agreements disguised as liquidity solutions, leaving projects vulnerable and retail investors misinformed. A particularly concerning arrangement is known as a “loan + call option” agreement.
In this type of contract, a project lends its native tokens to a market maker, who promises to provide liquidity in return. The market maker also receives call options, which allow them the right, but not the obligation, to repay these loans in U.S. dollars at a predetermined price. If the token’s value rises, the market maker can profit by buying tokens at a reduced rate and selling during the price surge. Conversely, even if the token underperforms, the market maker can still generate income by selling the borrowed tokens early, withdrawing support, or shorting the asset entirely, leaving the project to suffer while they secure profits.
If such practices were to occur in traditional equity markets, they would likely be deemed scandalous. For instance, consider a company going public on the NYSE while an undisclosed private entity engages in a backroom deal to sell discounted shares—without any public knowledge. Equity markets have safeguards to prevent such manipulation; the Securities Exchange Act of 1934 outlines regulations to protect against market manipulation during public offerings, ensuring fair trading practices.
Unfortunately, the crypto space lacks similar protective measures. As institutional investment surges, this absence of structure becomes a looming systemic risk.
The Need for Transparency in Crypto
It is not just retail investors or crypto-centric funds that are acquiring these digital assets; mainstream firms and institutional investors are also incorporating altcoins into their financial strategies, often without fully grasping the underlying market mechanics. This situation poses significant risks. When token prices are influenced by opaque agreements outside of public scrutiny, it compromises the asset’s integrity and misleads subsequent investors. Market fundamentals may appear robust, while they are actually maintained by short-term strategies and hidden incentives.
If these issues remain unaddressed, they could tarnish the reputation of digital assets at a time when they are beginning to gain mainstream acceptance. This lack of transparency could also trigger regulatory and shareholder backlash if firms incur losses linked to undisclosed risks that were previously unknown.
For the cryptocurrency sector to evolve into a legitimate and investable asset class, it is essential to bring these agreements into the light and ensure they are subject to professional accountability. Founders require tools to assess proposed contracts, model potential outcomes, and negotiate with informed awareness. Furthermore, regulators, fund managers, and institutional investors should demand basic transparency prior to engaging with new digital assets.
At the very least, all market-making arrangements should include standardized disclosures that clarify the structure of agreements governing liquidity. These disclosures should specify whether call options are part of the deal, outline the applicable strike prices and loan durations, and detail any hedging strategies that could affect token performance. Without such transparency, investors and project teams navigate without a clear understanding of the dynamics influencing token markets.
These measures are essential. Without them, we risk allowing sophisticated firms to operate in a state of ignorance, while exposing retail investors to unforeseen risks. As digital assets find their place on corporate balance sheets, the rules governing these assets must not remain shrouded in secrecy. They need to be open to scrutiny and regulation. Otherwise, we may inadvertently introduce the negative aspects of crypto into the core of Wall Street, only to realize too late that improvements were necessary.
