Room for improvement
zkMakers is a decentralized finance (DeFi) platform that aims to solve the inefficiencies and issues in the current crypto space market making ecosystem. Traditional market making has been the domain of large institutional players, who have access to a wealth of resources and infrastructure. This has resulted in a lack of liquidity for many digital assets and trading venues, especially for smaller exchanges and tokens. In addition, centralized market making can create single points of failure and increase the risk of market manipulation.
"Liquidity Mining: A Marketplace-Based Approach to Market Maker Compensation" by Michael Feng, Rajiv Bhat, and Carlo P. Las Marias, identified very well back in 2019 the main key issues of the Market Making industry:
- 1.Adverse selection: This refers to the practice of market participants utilizing asymmetric information to selectively transact in a market to benefit at the expense of other participants. This risk arises from the fact that bilateral contracts reward market makers for maintaining a predefined uptime percentage over a given month, but market makers can place, adjust, and cancel orders in real-time throughout the month. Market makers can selectively game bilateral contracts by placing orders during normal periods and not placing orders during the most abnormal periods, where n equals 1 minus their percent uptime obligation.
- 2.Monopolization risk: This refers to the danger of relying on a single source for liquidity provision. Given the high coordination costs of negotiating and maintaining bilateral contracts, most exchanges and issuers only engage with a few market makers, which increases dependence on them for liquidity.
- 3.Verification difficulty: For non-exchange market participants such as issuers who compensate market makers, verifying adherence with obligations stipulated in bilateral contracts and compliance with non-manipulative trading practices is highly challenging. To perform verification, non-exchange participants need access to high-resolution historical order book and trade data in each venue where their market makers operate. Ascertaining aggregate uptime, volume, and spread over an entire month requires specialized expertise in data engineering.
Other problems that we have identified:
- 4.Wash trading: is a pervasive issue in many financial markets, with some studies suggesting that up to 80% of trading volume is generated by wash trading activities (Chiu & Koeppl, 2019). This phenomenon involves market makers or traders generating fake orders to create the impression of liquidity and volume, thereby manipulating prices and benefiting from the resulting market movements.
- 5.Very few public accountability measures: with their activities often shrouded in secrecy. This lack of transparency makes it difficult for investors and other market participants to understand the true nature of the market and the activities of market makers.
- 6.Low organic or retail volume: in many financial markets, with much of the trading activity being driven by large institutional investors and market makers. This lack of retail participation can result in reduced market depth and liquidity, which can increase the likelihood of price volatility and other market inefficiencies.
- 7.Low incentives for market makers: to provide volume and liquidity on a multi-venue level. Market makers typically operate on a single exchange, where they can benefit from exclusive access to trading data and other advantages. This can lead to a lack of competition and reduced liquidity across different venues, which can ultimately harm the entire market ecosystem.
To address these issues, zkMakers is implementing a marketplace-based approach to promote consistent liquidity provision, mitigate the risk of manipulative practices, and improve matching efficiency in the market for liquidity.