The Game Between Project Tokens and Market Makers

Why should we strive to serve the project party with the tokens borrowed with strength? What exactly happens behind the scenes when the project party hands over the tokens to the market maker? This article will reveal the core logic of algorithmic market making, analyzing how market makers use the project party's tokens to exchange for trading depth, price stability, and market confidence.

Core Viewpoints

Due to the current lack of liquidity in altcoins, the optimal strategy for market makers under the bullish options model is to sell the tokens obtained from the project immediately. This may raise the question: if the tokens are sold right away, what if the token price rises in the future? Wouldn't the market makers need to spend a large amount of money to repurchase?

Market Maker Behavior Logic

1. Market makers adopt a delta-neutral strategy, do not hold positions, and pursue stable profits.

2. Call options have actually set a maximum price cap, limiting the maximum risk exposure for market makers.

3. Such market-making contracts usually last for 12-24 months. Considering the performance of numerous projects in the current market, most projects peak upon launch, and very few projects can last for a year.

4. Even if a project experiences a price surge after 1-2 years, the gains from the volatility of the coin price are sufficient to offset the losses from selling too early.

Market Background

Currently, there are three common cooperation models for market makers:

1. Lending Market Making Bots: Project parties provide funds (tokens and stablecoins), market makers provide technical and personnel support, and charge a fixed fee and/or profit sharing.

2. Proactive market making: The project party provides tokens (sometimes also provides some stablecoins), market makers provide funds for market making and guide the community, with the main purpose of selling tokens, and after completion, sharing the profits with the project party in proportion.

3. Call option model: The project party provides tokens, and the market maker provides funds (stablecoins), but the market maker has a call option, which allows them to exercise the option to purchase at a low price when the price exceeds the agreed price.

This article mainly discusses the most common bullish options patterns in the market.

Market Making Terms under Bull Call Option Model

From the perspective of delta-neutral market makers, the following cooperation terms are usually proposed (generally for 12-24 months):

centralized exchange market-making obligations

Market makers need to provide liquidity for Token ABC on the following exchanges:

• A major trading platform: provides buy and sell orders worth $100,000 within a price range of ±2%. The bid-ask spread is controlled at 0.1%.
• Other two trading platforms: Offering buy and sell orders equivalent to $50,000 within a range of ±2%, with a price difference also controlled within 0.1%.

Market-making obligations for decentralized exchanges

Provide a liquidity pool of 1 million USD for ABC on a certain DEX, with 50% in USDT and 50% in ABC Token.

The project party provides resources

The project party will lend 3 million ABC Tokens (which is 2% of the total token supply, currently valued at 3 million USD, implying a fully diluted valuation of 150 million USD) to the market maker.

The current market price of ABC is 1 dollar/Token.

Options Incentive

If the price of ABC Token rises in the future, the market maker can choose to exercise the option to purchase the tokens, with the specific terms as follows:

• When the price exceeds $1.25, you can buy 100,000 tokens at the price of $1.25.
• When the price exceeds $1.50, you can buy 100,000 tokens at the price of $1.50.
• When the price exceeds $2.00, you can buy 100,000 tokens at the price of $2.00.

If the market price does not reach the corresponding exercise price, the market maker can choose not to exercise and bear no obligations.

Market Maker's Operating Strategy

Core Objectives and Principles

1. Always maintain Delta neutrality: The net position (spot + perpetual contracts + LP + options Delta) must always be close to zero to fully hedge against market price volatility risk.

2. No directional risk: Profits do not depend on the price fluctuations of ABC Token.

3. Maximize non-directional returns: Sources of profit include the buy-sell spread of centralized exchanges, trading fees from liquidity pools in decentralized exchanges, volatility arbitrage achieved through hedging over-the-counter options, and potential favorable funding rates.

Initial Setup and Key First Step: Hedging

Received assets (which are also liabilities): 3 million ABC Tokens. This is a loan that needs to be repaid with 3 million ABC Tokens in the future.

Obligation Deployment (Inventory and Funds):

• Centralized exchange market making: 200,000 ABC (sell order) + 200,000 USDT (buy order)
• Decentralized Exchange LP: 500,000 ABC + 500,000 USDT
• Total market-making inventory: 700,000 ABC
• Total USDT required for market making: 700,000 USDT

Initial Net Exposure Calculation:

• Initially held 3 million ABC
• Used 700,000 ABC as the sell order inventory for the exchange and DEX.
• Need to sell 700,000 ABC to exchange for 700,000 USDT for market making.
• The remaining 1.6 million ABC represents the true net long position.

Initial hedging operation: Immediately sell a total of 2.3 million ABC. Among them, 700,000 ABC is used to exchange for 700,000 USDT needed for market making, and the other 1.6 million ABC is used to hedge the remaining unhedged Token positions.

Dynamic Hedging: All-Weather Risk Management

• Centralized exchange market-making hedging: When a buy order is filled, immediately short an equal amount of ABC in the perpetual contract market, and vice versa.
• Decentralized Exchange LP Hedging: Continuously calculate the Delta of LP and hedge in the opposite direction with perpetual contracts.

Options Strategy: Core Profit

• Use the options pricing model to calculate the total Delta of the three-tier options at the current price, and short the corresponding amount of ABC in the perpetual contract market to maintain neutrality.
• Dynamically adjust hedging positions through the Gamma Scalping strategy to profit from market fluctuations during price volatility.
• Increase hedging short positions when the price approaches and exceeds the strike price. At the expiration of the options, if the price is above the strike price, exercise the option and immediately sell the acquired Token on the market while closing the hedging position.

Conclusion

1. Initial Token Handling: Immediately sell 2.3 million ABC Tokens, of which 700,000 are used to acquire operational USDT, and 1.6 million are used to hedge remaining positions.

2. When the price is below $1.25: Do not actively buy or sell non-hedging ABC. Continue market making on exchanges, DEX LP hedging, and options Gamma Scalping.

3. When the price is above the strike price: Execute a risk-free delivery process, buy tokens from the project party at a low price, immediately sell them in the market at a high price, while closing the hedged position.

This strategy transforms complex market-making agreements into a series of quantifiable, hedgeable, and profitable risk-neutral operations. The success of market makers does not rely on market predictions but rather on excellent risk management capabilities and technical execution.

Under this mechanism and algorithm, it is a locally optimal solution for market makers to initially "sell" Tokens and open short positions. This is not malicious behavior, but a rational choice after weighing the pros and cons. The cruelty of the market lies in the fact that seemingly the most favorable and risk-free agreements are often the result of precise calculations. If risks cannot be identified, then one may become a risk point themselves.

We should always maintain a sense of awe for market algorithms.