From: thepipeline_xyz
Market making in the crypto space operates fundamentally differently from its counterpart in traditional finance (TradFi) 00:02:06. While both aim to provide liquidity and facilitate trading, the underlying profit mechanisms, operational transparency, and technological considerations diverge significantly.
Profit Centers and Strategies
In traditional finance, the primary profit center for market-making firms lies directly in the profit and loss (P&L) derived from their trading activities in the market 00:02:08. What they earn from market movements and spreads is what they take home 00:02:14.
In crypto, this is often not the case 00:02:16. Many crypto market makers engage in very basic operations, sometimes just running simple scripts to deploy liquidity on order books 00:02:22. Their actual profit center does not typically come from the performance of their trading algorithms, which often break even 00:02:28. Instead, they earn money by charging exchanges and protocols for access to their market-making services 00:02:35.
This difference in profit motivation led to the inspiration behind projects like Elixir, which aims to demonstrate that a decentralized, trustless protocol could perform the same market-making function 00:02:46. Elixir builds a modular DPOS Network to power order book liquidity, allowing anyone to supply liquidity to order books 00:02:52. The protocol algorithmically deploys this liquidity to tighten bid-ask spreads and deepen order book liquidity 00:03:00. Liquidity providers (LPs) on Elixir experience a risk-return profile nearly identical to those on Uniswap V2, by design, as the goal is to simplify the complex space of market making for users 00:03:10.
Transparency and Infrastructure
Market making on-chain introduces unique transparency considerations compared to centralized exchanges. On both a decentralized order book and a centralized exchange’s order book, users can see where orders are placed and query the state of the order book to place their own orders accordingly 00:23:37.
However, additional transparency on-chain can reveal information like a market maker’s leverage, which could expose their liquidation levels and be valuable information for other traders 00:24:04.
When considering an on-chain Central Limit Order Book (CLOB), there are key differences:
- Off-chain CLOBs settling on-chain: Most large decentralized exchanges (DEXs) like dYdX, Vertex, RabbitX, Hyperliquid, and Aevo utilize off-chain modules that settle transactions on-chain 00:25:27. This approach is recommended because it avoids high gas fees for updating orders, which would force market makers to update less frequently and quote wider spreads 00:25:45. It also mitigates manipulation attempts, such as spamming transactions to prevent liquidations 00:30:26. These off-chain models offer faster, cheaper order updates and allow for gasless operations for LPs 00:29:57, 00:33:05.
- Fully on-chain CLOBs: While possible, fully on-chain order books, even on fast chains like Solana, tend to have wider spreads and less optimal execution because of the cost and latency associated with on-chain order updates 00:26:50. This makes it difficult for market makers to achieve tight spreads and frequent updates (e.g., 10-30 times a second) typical of high-frequency trading (HFT) firms 00:27:10.
Even with on-chain transparency, protocols like Elixir incorporate mechanisms such as provable randomness to prevent predictable order placement and deter adversarial trading 00:28:21. For example, a variable that fluctuates between 0 and 1 determines the algorithm’s focus (balancing books vs. optimizing P&L), and a random percentage of orders might not make it to the exchange, making it unprofitable for others to trade against Elixir’s algorithm 00:28:57.
Benefits for the User
For users, especially those new to crypto, on-chain CLOBs offer several significant advantages over centralized exchanges:
- Custody: Users retain custody of their assets at all times 00:35:42. This eliminates the need to trust a third party with funds, as seen with past exchange hacks or collapses 00:35:56.
- Fairness: The transparent nature of on-chain operations means the exchange itself cannot trade against its users, preventing predatory practices like liquidating users for profit 00:36:18.
- Deeper Liquidity: Protocols like Elixir contribute to deeper liquidity on decentralized exchanges by allowing passive liquidity provision, which makes trading more efficient 00:36:24.
- Improved User Experience: On high-throughput, low-gas chains like Monad, CLOBs can enable features like one-click trading by using signatures for approvals, eliminating the need for multiple approvals for every trade 00:37:51. This allows users to keep funds in their own wallets (e.g., MetaMask, Ledger) while still trading seamlessly 00:38:16.
The evolution of crypto markets is increasingly seeing AMMs moving towards order book models (e.g., Uniswap V3’s concentrated liquidity, V4’s hooks for limit orders) 00:11:37. The ability to passively supply liquidity, a key strength of AMMs, is now being adapted for order books, bridging the gap between the two models 00:12:05. This signifies a push towards more efficient, decentralized trading environments for end-users 00:09:50.