Suppose you have done all the steps to create an excellent DeFi project and did everything correctly. In that case, your next most significant challenge will be planning a budget for all the money you raise through the ICO.
Liquidity issues with most ICOs are well-known. There are tried-and-true tools to make it, which is something that is not widely known in the crypto space. Most new or “exotic” assets are based on this condition, which is not specific to the cryptocurrency markets.
The “conventional” capital markets do not exhibit a liquidity shortage since a whole industry has been developed to address this issue. It’s known as market making.
This post is for you if you are preparing an ICO and don’t have a market-making strategy.
Market Makers, Who Are They?
It’s crucial to comprehend the fundamentals of market making before delving into the problem of ICO liquidity and possible solutions from market makers. If you are not a trader, it’s likely that you only see investors, day traders, and speculators on one side of the market. They are all referred to as market takers. They drain the market of its liquidity. Whether it takes them minutes, days, or years, they want to profit from their deals after that. Market participants value two things:
- Liquidity, or the ability to execute the desired magnitude at the lowest cost.
- Immediacy, or the capacity to complete the transaction as soon as feasible.
Market participants deliberately assume risks related to their positions. They purchase or sell various financial products because they are prepared to accept the accompanying risk and believe they will benefit in the long run.
On the opposite side of the equation, market makers act as the financial market’s “invisible hand.” Market makers offer liquidity while earning a profit from the market spread. You will likely trade against one of your purchasing or selling assets.
The spread is the distinction between the purchase and sell prices on the market, such as when exchanging money at a currency exchange kiosk or simply the difference between the bid and ask (or bid-offer) prices. The way the exchange kiosks generate revenue differs. In a similar vein, market makers profit from the spread.
The spreads are minimal in liquid markets with numerous buyers, sellers, and market makers. Market makers must execute a very high number of deals to turn a profit. Using highly sophisticated quantitative algorithms, they take very short-term positions, which might be hours, minutes, or seconds. Market makers can execute more deals and generate more profit when there is greater asset volatility (i.e., sufficient market movement) and trading volume.
Market making is not risk-free, though. Risk is assumed by ICO market makers at the discretion of external market takers. They first earn a profit but later control their risks. A FOMO rally with no sellers or a panic sale would typically provide a challenge for them. However, if there was an equal number of buyers and sellers on a screen, they would have essentially little risk at the end of the day.
What The “ICO Liquidity Trap” Is And Why Crypto Marketplaces Lack Liquidity
The trading volume of the top 20 cryptocurrencies is sufficient for market makers to engage in unrestricted competition. On the other side, smaller coins and ICOs experience what I refer to as an “ICO liquidity trap.” This occurs as a result of a lack of market makers who are actively supplying them with liquidity.
Cryptocurrency exchanges and investors are vital participants in ICOs that support token liquidity. To participate, cryptocurrency exchanges and investors need to be sure that the market is liquid. A vicious loop is so created. Let’s take a closer look at it.
When attempting to obtain an exchange listing, ICO issuers encounter a bottleneck. Even with the less expensive ones, you must spend substantial 6-digit sums. For a listing, reputable crypto exchanges like Binance could charge seven-figure amounts.
To launch a new token, cryptocurrency exchanges must incur hefty setup fees (due diligence, cold storage, etc.) Therefore, if they are uncertain about the potential liquidity of a new listing, they are not overjoyed by the idea. Exchanges don’t want another “ghost town” token on their platform. There is little to no trade, and a swarm of furious investors is seeking to unload what tokens are still there.
How Can Market Makers Address The Issue Of ICO Liquidity?
Market makers are necessary for cryptocurrency markets, just as in traditional markets, to help direct the “invisible hand” of the market and escape the ICO liquidity trap. A skilled ICO market maker’s services can help the market for your tokens grow. And the magic comes after the ICO adds a market maker:
- Exchanges relax their stance on the listing procedure.
If an ICO comes to them with a Market Maker attached, exchanges have one less issue. They would be more inclined to demand a lower listing cost if they knew that professional market makers were being used to generate liquidity for the new cryptocurrency.
- Greater liquidity attracts new and sophisticated investors
A new investor can swap in and out of his stakes for less money the more competitive the market for your ICO is. This, in turn, may draw a more diversified trading community (including institutional investors) that uses very various trading tactics that would not be practical otherwise.
Furthermore, a liquid market keeps large orders from destabilizing it, fostering confidence in the token.
Therefore, having a market maker aids in both attracting investor interest and helping you become listed on a cryptocurrency exchange. Market making should be “a baseline service that every crypto projects have to deliver to investors before listing on an exchange,” according to this excellent essay.
- Liquidity encourages more liquidity
Amazingly, as the ecosystem of investors expands, the order book fills up with additional orders, improving the liquidity available to market makers. Market makers start raising the number of their orders as the number of market takers rises (volume is their friend, remember). Then, additional market makers will appear for free as trading volume increases, drawn in by the attractive figures. When the initial listing is liquid, an ICO would have more negotiation power with the exchange to get a secondary exchange listing.
- The token price rises as a result of volume and investor confidence
A project’s visibility would increase with higher quantities, attracting supporters (and haters). The vast majority of such attention will encourage other individuals to consider investing in the coin. The price would increase as demand increased.
Note this important point; remember to include a professional market maker in your budget planning if you are an ICO or cryptocurrency project!
For an ICO to be successful, you must get quite a few things right. One of them is liquidity. It supports your token economics and aids exchanges and investors in giving your ICO the most significant potential outcome. However, cryptocurrency liquidity is rarely a given.
You require the assistance of seasoned market makers with the resources to kickstart the trading of your token to establish a liquid market for your ICO. When preparing your ICO budget, be sure to take market-making requirements into account and account for this service.