Author: @agintender
Original link: https://x.com/agintender/status/1946429507046645988
Disclaimer: This article is a reprint. Readers can obtain more information through the original link. If the author has any objections to the form of reprint, please contact us, and we will make modifications as per the author's request. Reprinting is for information sharing only and does not constitute any investment advice, nor does it represent the views and positions of Wu Shuo.
Why should tokens borrowed with strength be used to help you do business? What really happens after the project party hands over the tokens to the market makers? This article will unveil the core logic of algorithmic market making and analyze how market makers use your tokens to gain trading depth, price stability, and market confidence.
Conclusion first: Due to the current lack of liquidity in altcoins, the optimal solution for market makers under the call option model is to sell the project party's tokens immediately after obtaining them. You might ask, if they sell the tokens right away, what if the tokens rise in the future? Wouldn't the market makers need a lot of money to buy them back?
Reasons:
The strategy of market makers is delta neutral; they do not take positions—what they want is to ensure profit without loss.
The call option actually limits the maximum price, thus limiting the market makers' maximum risk exposure (even if you surge 100 times, I can still buy at 2 times the price).
These types of market maker contracts are usually 12-24 months long. Given the number of projects currently in the market, most peak right after launch; how many can last until a year later?
Even if they survive 1-2 years, if the token price skyrockets, the profits from price fluctuations will be enough to cover the losses from the early "sell-off."
Introduction
Recently, the market has been doing well, and several friends around me have projects that want to have their Token Generation Event (TGE) soon. They are currently stuck on the choice of "market makers." They all come to me with the terms from market makers, asking what I think of these conditions. Are there any pitfalls? What will market makers do with our tokens? Will they really provide liquidity?
Especially after seeing the report on Movement: https://cn.cointelegraph.com/news/movement-network-binance-38-million-buyback Disclaimer: The plot is purely fictional; any resemblance to actual events is coincidental. Nitpicker's statement: If you think I'm wrong, then you are right. Entertainment statement: This article is written with the utmost "malice," not targeting anyone; just take a look for fun.
1. Market Background
Generally speaking, the common cooperation models for market makers now are threefold:
Renting market-making bots - The project party provides funds (tokens + stablecoins), and the market maker provides "technology" and "personnel" support, charging a retainer fee and/or a profit-sharing fee (if applicable).
Active market makers - The project party provides tokens (sometimes a bit of stablecoins), and the market maker provides funds (sometimes not providing stablecoins) for market making and community guidance, primarily aiming to sell tokens. After selling the tokens, the project party and the market maker share the profits proportionally.
Call option (common) - The project party provides tokens, and the market maker provides funds (stablecoins), but the market maker has a call option, allowing them to buy at a low price once the price exceeds the agreed price.
This article mainly explains the most common 3. call option model.
2. Market Making Terms for the Call Option Model
From the perspective of a delta neutral market maker, the following project cooperation terms are generally provided (usually 12-24 months):
Note: Purely fictional; if it seems familiar, it’s just familiar.
CeFi Market Making Obligations
The market maker needs to provide liquidity for token ABC on the following exchanges:
Binance: Place buy and sell orders worth $100,000 each within a ±2% price range (i.e., you bear $100k USDT + $100k worth of ABC). Control the spread at 0.1%.
Bybit and Bitget: Similarly, provide buy and sell orders worth $50,000 each within a ±2% range (you need to invest $50k USDT + $50k worth of ABC), with the spread also controlled at 0.1%.
DeFi Market Making Obligations: You need to provide a liquidity pool of $1,000,000 for ABC on PancakeSwap, with 50% in USDT and 50% in ABC tokens (i.e., $500k USDT + $500k ABC).
Project Party Provides Resources: The project party will lend you 3 million ABC tokens (i.e., 2% of the total token supply, currently valued at $3M, meaning an FDV of $150M).
The current market price of ABC is $1/token.
Project Party's Option Incentives (European Call Options): If the market price of ABC token rises in the future, you can choose to exercise the option to purchase tokens, with specific terms as follows:
| Strike Price | Quantity (ABC) | Exercise Conditions | |--------------|----------------|---------------------| | $1.25 | 100,000 | If market price > $1.25, can buy at $1.25 | | $1.50 | 100,000 | If market price > $1.50, can buy at $1.50 | | $2.00 | 100,000 | If market price > $2.00, can buy at $2.00 |
If the market price does not reach the corresponding strike, you can choose not to exercise, incurring no obligations.
Based on the above conditions, as a market maker strictly executing a delta-neutral strategy, how would you conduct overall market making and hedging arrangements after obtaining these 3 million ABC tokens to ensure you do not incur losses due to token price fluctuations?
3. Reflection: If you were the market maker, what would you do?
3.1. Core Goals and Principles
Always maintain Delta neutrality (this is the premise): The net position (spot + perpetual contracts + LP + option Delta) must always be close to zero to fully hedge against market price fluctuation risks.
Do not take directional risks: Profits should not depend on the rise or fall of ABC token prices.
Maximize non-directional profits: Profits come from four core channels:
a. Buy-sell spread on centralized exchanges (CEX).
b. Trading fees from liquidity pools (LP) on decentralized exchanges (DEX).
c. Volatility arbitrage (Gamma Scalping) achieved through hedging over-the-counter options (OTC Options).
d. Potential favorable funding rates.
3.2. Initial Setup and Decisive First Step: Hedging
This is the most critical step in the entire strategy. Actions are determined not by price predictions but by the assets received and obligations undertaken.
3.2.1 Asset and Obligation Inventory
Assets Received (also liabilities): 3,000,000 ABC tokens. This is a loan, and we are obligated to repay 3,000,000 ABC tokens in the future.
Obligation Deployment (Inventory and Funds):
Binance Market Making: 100,000 ABC (sell order) + 100,000 USDT (buy order)
Bybit/Bitget Market Making: 100,000 ABC (sell order) + 100,000 USDT (buy order)
PancakeSwap LP: 500,000 ABC + 500,000 USDT
Total Market Making Inventory: 700,000 ABC
Total USDT Required for Market Making: 700,000 USDT
3.2.2 Initial Net Exposure Calculation (Simple Calculation Version)
Note: The numbers are not important; the logic is more important.
If we only look at the token loan itself, holding 3 million ABC perfectly hedges the obligation to repay 3 million ABC. However, as a market maker, we cannot only look at the loan; we must consider the net position of the entire business.
USDT Funding Gap: Market making obligations require us to immediately put out at least 700,000 USDT to provide buy order liquidity. Where does this money come from? The most direct, protocol-compliant, and market-appropriate way, given that new tokens peak right after launch, is to sell part of the borrowed ABC tokens to obtain it.
ABC that must be sold to obtain USDT: To obtain 700,000 USDT at the current price of $1, we must sell at least 700,000 ABC. (Generally, this will be done in the "initial liquidity window" or OTC; conscientious market makers will usually open a long position to hedge a bit.)
Recalculate net exposure: Initially, we have 3 million ABC.
Using 700,000 ABC as CEX and DEX sell order inventory.
At this point, the remaining ABC is: 3,000,000 - 700,000 (inventory) - 700,000 (sold for USDT) = 1,600,000 ABC. Now, this 1.6 million ABC is the true net long exposure (Net Long Delta). We no longer have a USDT funding gap, but the 1.6 million tokens we hold are unhedged; if the price drops, we will face losses.
3.2.3 Initial Hedging Operation: Answering "When to Sell?"
The answer is: Sell immediately. The amount sold is precisely calculated to achieve two goals: 1) Obtain the USDT needed for operations; 2) Hedge the remaining token exposure.
Action: At the very start of market making, our automated trading system will immediately sell a total of 2,300,000 ABC on the market. Of these, 700,000 ABC is to obtain the 700,000 USDT needed for market making. The other 1,600,000 ABC is to hedge the remaining unhedged token position.
Why do this:
Meet operational needs: This provides us with the necessary dollar liquidity to fulfill all market making obligations. Achieve true Delta neutrality: After selling all 2.3 million ABC, we no longer have any unhedged ABC token exposure. Our risk is completely neutral. Lock in risk: We completely transfer the risk of price fluctuations and focus solely on profiting from market making and volatility.
We will not hold any "naked" ABC tokens waiting for the price to rise. Every token position, whether positive or negative, must be precisely hedged.
3.3. Dynamic Hedging: 24/7 Risk Management
After the initial hedging is completed, our risk exposure will continuously change due to market making activities and market fluctuations, requiring ongoing dynamic hedging.
CEX Market Making Hedging: When our buy orders are filled, we will buy ABC (creating long Delta), and the system will immediately short an equivalent amount of ABC in the perpetual contract market. The opposite is also true. We earn a 0.1% spread in this way while maintaining Delta neutrality.
DEX LP Hedging: The 500,000 ABC inventory in PancakeSwap carries the risk of impermanent loss, which is essentially a short Gamma position. Our model continuously calculates the Delta of the LP (negative when prices rise, positive when they fall) and uses perpetual contracts for reverse hedging.
3.4. Options Strategy: The True Profit Engine
This is the most sophisticated part of the entire trading process and the key to our surpassing simple market makers to achieve excess profits.
3.4.1 Understanding the Value of Options
What we hold is not tokens, but a right. This right (three-tier call options) has positive Delta and positive Gamma. This means:
Positive Delta: As the price rises, the value of the options increases.
Positive Gamma: The more volatile the price changes, the faster the Delta changes, which is more beneficial for us.
3.4.2 Hedge Options, Not Hold Tokens
We will not simply wait for the price to reach $1.25, $1.50, or $2.00. We will hedge the Delta of the options.
Initial Hedging: Using an options pricing model (like Black-Scholes), we calculate the total Delta of these three options at the current price of $1.00. Suppose it calculates to +400,000. To maintain neutrality, we must short an additional 400,000 ABC in the perpetual contract market. (The larger the option, the more we need to short.)
Gamma Scalping: This is the dynamic answer to "when to buy and sell."
Scenario 1: If the price rises from 1.00 to 1.10, the Delta of the options will increase (as it gets closer to the strike price), for example, from +400,000 to +550,000.
Our net position is no longer 0, but has a long exposure of +150,000. Action: Our system will automatically sell 150,000 ABC in perpetual contracts to re-establish neutrality. Scenario 2: If the price drops from 1.10 to 1.05, the Delta of the options will decrease, for example, from +550,000 to +500,000.
Our existing short hedging position becomes "excessive," resulting in a net short exposure of -50,000. Action: Our system will automatically buy 50,000 ABC in perpetual contracts to cover, once again achieving neutrality.
Isn't it amazing?! Through hedging, we naturally achieve "selling high and buying low." This process repeats continuously, allowing us to "extract" profits from every market fluctuation, which is Gamma Scalping. We earn from volatility, not from directional moves.
3.4.3 Operations Near the Strike Price
When the price approaches and exceeds $1.25: Our first-tier option becomes in-the-money (ITM). Its Delta will quickly approach 1 (1,000,000).
Our short hedging position will also increase accordingly to nearly 1,000,000 ABC. Exercise Decision: At the option's expiration, if the price is above $1.25, we will exercise. Action: Pay $1,250,000 USDT to the project party to obtain 1,000,000 ABC tokens. Immediately sell these 1,000,000 ABC tokens in the spot market. At the same time, close out the 1,000,000 ABC perpetual contract short position we established to hedge this option. Profit: The profit comes from the difference between the strike price and the market price, as well as the accumulated gains from Gamma Scalping throughout the process.
The logic is exactly the same for strike prices of $1.50 and $2.00. We are not betting on whether the price will reach these levels; instead, we continuously profit by dynamically adjusting our hedging positions during price fluctuations and executing risk-free arbitrage when the price actually reaches these levels.
3.5. Conclusion and Operational Recommendations
Initial Token Handling: Immediately sell 2.3 million ABC tokens, with 700,000 used to obtain operational USDT and 1.6 million used to hedge remaining positions. Never hold any unhedged token positions.
Price $1.25: Do not actively buy or sell any non-hedged ABC. Continue CEX market making, DEX LP hedging, and options Gamma Scalping. Profits come from spreads, fees, and volatility.
Price > $1.25 (and subsequent strike prices): When the price is significantly above the strike price, our hedging engine has already established corresponding short positions for us. Exercising becomes a risk-free delivery process: buy tokens from the project party at a low price and immediately sell them at a high price in the market while closing out the hedging position.
This strategy breaks down a seemingly complex market making agreement into a series of quantifiable, hedgeable, and profitable risk-neutral operations. The success of market makers does not rely on market predictions but on excellent risk management capabilities and technical execution.
After reading this, I hope you understand that it is not that market makers have a grudge against you and "deliberately" crash the market; rather, under this mechanism and algorithm, selling tokens and opening short positions at the beginning is the locally optimal solution of the market making strategy.
It is not that they are bad, but rather a rational choice after weighing the pros and cons.
The market is cruel; deals that seem better and less risky are often the result of precise calculations.
When you cannot see the risk points, you are the risk point.
May we always maintain a sense of awe towards market algorithms.
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