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Crypto market-making superpowers: Hidden Call Options

It seems like everyone defines crypto market-making slightly differently: ask 10 industry OGs and you will get 10 variations of a similar concept. While it may be difficult to pin down crypto market-making, there is one definite characteristic that puts crypto market makers in a unique position to benefit from the growth of the industry. The former CEO of Alameda Research Sam Trabucco added to the secrecy by tweeting about crypto “market-making superpowers” - a hidden way to take on exposure to tokens of up-and-coming & ambitious projects, without directly deploying capital.

The secret behind crypto market-making superpowers is in the liquidity Service Level Agreements (SLAs) that are structured as loans of native tokens, with a cash repayment option. The crypto market maker quotes a tight spread & deep orderbook and in return asks for a loan of the native tokens, but with an ability to repay it with stablecoins. As an example, a crypto market maker would commit to provide liquidity and he would ask for a loan of tokens worth $1’000’000, with the option to repay the loan with USDT, instead of with native tokens.

Isn’t this an awesome deal?! The project creates tokens out of thin air, gives them to the crypto market maker for liquidity services, does not actually pay with cash, and there’s even a possibility of getting “real” money from the crypto market maker. Where is the Trojan horse in these beautifully structured SLAs?

My readers & projects’ CEOs might look suspiciously at the funny-looking loan structures; these SLAs are hiding an American Call Option, that enable crypto market makers to profit from the extreme upside & volatility of tokens. The real crypto market-making superpower the former CEO of Alameda Research was referring to, is not about blindly deploying capital into random tokens & meme coins - crypto market makers don’t do that - but to have optionality on the rapid growth of the crypto industry.

Just to say the obvious, these kind of SLAs would never be allowed in the regulated world, because market makers have a conflict of interest - they should provide liquidity in an undirectional manner, but the “rational” & unethical behavior would be to pump the token, exercise the American Call Option, dump in the open market (on retail traders) and make a killing. Finally, it’s shocking to find out how much such SLAs cost the project, since they are giving an American Call Option to the market maker for free - in the above example of an SLA on tokens worth $1’000’000, the American Call Option is worth $400’000. Not a bad business for crypto market makers!

Following the fiasco with FTX & Alameda Research, a lot of nonsense bordering science fiction has been pushed onto the public, mostly by people with no industry experience - my goal is to provide insights how the industry operates and shed a light on the behind-the-scenes & secretive workings. More to come!

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