Crypto Market Makers See 30% Drop in Profit Margins Amid Industry Changes

The crypto market has witnessed a significant decline in profitability, with profit margins taking a sharp 30% hit. 

This decline comes in the wake of significant changes within the crypto industry, including soaring costs and investors’ wariness following the $2 trillion market downturn.

Recent events, such as the FTX exchange’s bankruptcy, left numerous coins stranded on collapsed platforms and triggered concerns of ongoing instability. 

Market makers have since made their efforts to mitigate the risks associated with future turmoil, a shift that has taken a toll on their profit margins.

Crypto companies are now diversifying their activities across multiple exchanges, a strategy aimed at minimizing their exposure to potential disruptions. 

Additionally, they are storing digital asset inventories away from trading platforms and using them as collateral to borrow tokens for deployment on crypto platforms. 

By keeping collateral at custodians or prime brokers and only exposing the tokens borrowed from lenders, they aim to reduce risk. 

However, this approach has resulted in a 20%-30% drop in profitability for the market-making compared to the traditional method of depositing and leveraging coins directly with a trading site.

Le Shi, Head of Trading at Auros, acknowledged that the industry had received a “wake-up call” from the FTX debacle. He emphasized that leaving assets on exchanges without prioritizing the associated risks was no longer acceptable. 

While these measures may lead to higher costs, they are seen as an essential part of conducting business securely in the evolving crypto landscape.

A Look Back at the Crypto Boom

In the bull run of 2021, the business of facilitating crypto trades and profiting from price differentials between buying and selling was immensely profitable for market makers. 

Wintermute, for instance, reported trading volumes of $1.5 trillion, revenue of $1.05 billion, and profits of $582 million with a team of just 53 in 2021. 

However, the crypto market has seen a significant shift since then. 

The total crypto market value, which once exceeded $3 trillion, has plummeted to $1.1 trillion, mainly due to rising interest rates and decreased speculative enthusiasm. 

Market-making firms like Jane Street Group and Jump Crypto have scaled back their involvement in digital assets amid low trading volumes, declining volatility, and increased regulatory scrutiny in the United States.

A Flight to Quality Amid Market Uncertainty

To mitigate risks, market makers are now seeking to reduce their exposure to centralized exchanges, which they perceive as a vulnerability. 

GSR Markets, historically active in trading smaller coins, is redirecting its focus towards the two largest tokens, Bitcoin and Ether, in a “flight to quality” strategy. 

This strategic shift may come at the cost of lower margins, but it offers more volume and opportunities in the current market environment.

While centralized exchanges have traditionally dominated the trading of spot tokens, crypto also offers decentralized, peer-to-peer platforms like Uniswap, where trading occurs via blockchain-based smart contracts, with users retaining custody of their tokens.

The decline in monthly spot trading volumes at centralized exchanges, a 74% decrease to $445 billion in August compared to January 2022, shows the retreat of liquidity providers. 

Market depth, reflecting the market’s ability to accommodate large orders without causing substantial price fluctuations, has also diminished, with the number of trades within 2% of Bitcoin’s mid-price falling by more than 60% since October of the previous year.

Hope Amidst Challenges

While digital assets have partially rebounded in 2023 from the previous year’s steep selloff, they remain far from their all-time highs. 

Bitcoin, for instance, has seen a 56% increase in value since the start of the year but is still trading well below its 2021 record.

Despite the challenges, crypto companies are optimistic about future gains, particularly if the pending applications for the first spot Bitcoin exchange-traded funds (ETFs) in the United States receive approval. 

Some companies are looking to Asia as a potential source of growth, citing clearer regulations as a catalyst for regional crypto demand.

NB: Any Information provided here is NOT FINANCIAL ADVICE. Do Your Own Research before making any Financial Decisions.