Market-Making Agreements Are Harming Promising Crypto Projects

Market-making agreements in the cryptocurrency space can significantly impact the success of new blockchain projects. Many founders unknowingly enter into unfavorable agreements that may provide liquidity but ultimately harm their projects and investors. This article highlights the issues with current market-making practices and calls for greater transparency and better alternatives to protect both new projects and retail investors.

Key Takeaways

Market-making agreements can lead to significant price drops, as seen with the Movement token.
Many founders enter into "loan + call option" agreements, which can be unfair to them.
Market makers often misprice options, prioritizing profit at the cost of project success.
Many projects lack alternatives to these agreements due to limited funds.
A lack of transparency and industry standards complicates the situation for token founders.
The crypto industry needs standardized disclosures and better education on market-making practices.

Every market-making agreement should come with standardized disclosures, and it should be made plain to teams and token holders alike.

The Issues with Current Market-Making Agreements

When the Movement Foundation experienced a dramatic 20% drop in its token earlier this year, it was a wake-up call for many in the crypto community. The price plunge followed a coordinated $38 million sell-off orchestrated by a market maker, leaving retail investors in a difficult position. In a swift response, major exchanges like Coinbase delisted the token, and Binance suspended any profits tied to it, while the project's founders rushed to distance themselves from the incident.

This incident isn't an isolated event but rather highlights a serious problem within the crypto ecosystem. The market-making firms responsible for providing liquidity hold disproportionate influence, utilizing opaque loan agreements that can decimate token prices, enrich themselves, and keep investors uninformed.

Despite crypto's focus on decentralization, one of the market's most vital components is often controlled by unclear agreements that undermine project founders and reward middlemen—even when those projects fail.

Understanding the 'Loan + Call Option' Model

Founders typically do not approach market makers with the expectation of being taken advantage of. They seek better liquidity, tighter spreads, and improved price discovery for their new tokens. However, what they often receive are unfairly priced call options, incentives that skew against them, and structural disadvantages that are difficult to reverse.

Market makers are not inherently harmful; they operate as businesses and have witnessed numerous unsuccessful token launches—over 1.8 million this year alone. Consequently, they implement strategies to safeguard their profits regardless of whether a new token is well-received or quickly declines.

The "loan + call option" agreement is the favored structure among market makers. Here, the project loans its native tokens to the market maker, who is supposed to provide liquidity in return. The market maker gains additional optionality on the borrowed tokens, allowing them the choice to repay the loan in cash if the token's price surges.

While this arrangement appears beneficial on the surface, it rarely works out well. Oftentimes, the options are mispriced, with strike prices set significantly higher than the current market price. Furthermore, vesting schedules are typically back-loaded, and the market maker frequently has insight into the likelihood of these options becoming profitable.

To mitigate risk, market makers may sell or short the tokens. Their focus shifts from fostering a healthy market to securing riskless profit, disregarding the implications for the projects they are meant to support.

Limited Alternatives for Most Projects

Many projects accept these terms simply because they feel they have no choice. A more favorable approach exists—a retainer model where projects supply both tokens and stablecoins to the market maker for their services. However, this requires substantial capital reserves that most teams lack.

After allocating significant funds to legal compliance and other operational expenses, many founders find it challenging to cover both liquidity and ongoing project needs. As a result, they opt for the cheaper alternative: lending tokens in exchange for liquidity, hoping for a successful outcome.

Unfortunately, this seldom ends well. Some desperate founders may even use their native tokens as collateral to raise funds to artificially inflate their market prices. While this can create a temporary boost, it often leads to severe sell-offs once the market makers vest and exercise their options. Retail investors become disillusioned, and project valuations crash, leaving founders bewildered regarding the sustainability of their strategies.

The underpinning issue is the significant knowledge gap between market makers, often derivative experts, and founders, who are primarily focused on product development. This leads to unfair terms and liabilities that may not come to light until it's too late.

The Need for Transparency in Market Making

The current lack of transparency in crypto market-making is concerning. There are no industry benchmarks or standardized disclosures; every agreement tends to be unique and negotiated behind closed doors. Moreover, in an environment characterized by urgency, founders may not fully appreciate the consequences of these agreements until it’s too late.

What the industry needs is not only better deal structures but a framework to evaluate them effectively. Market-making agreements should come equipped with standardized disclosures, making details such as option strike prices, hedging strategies, and vesting schedules clearly visible to teams and token holders alike.

Founders need access to the right tools to benchmark and assess whether a deal is fair. If they could simulate outcomes across various market scenarios, they would likely avoid terms that are disadvantageous.

Education is essential. Just as traditional companies wouldn't proceed with an IPO without a knowledgeable CFO, crypto projects shouldn't launch a token without a comprehensive understanding of market-making mechanics.

In the long run, the crypto space requires innovative liquidity models—whether through decentralized autonomous organizations (DAOs), pooled treasuries, or founder-friendly trading desks—to lessen the need to sacrifice significant potential gains simply to maintain a functioning market. These alternatives will take time to develop, but they will have no chance of emerging if the status quo is not challenged.

For now, the cryptocurrency community must confront the reality: the liquidity provisioning structure is flawed. If we fail to address these issues, the core values we strive for in this space—fairness, decentralization, and ownership—will continue to deteriorate behind undisclosed contracts that remain unexamined.