Unveiling the Core Logic of Algorithmic Market Making

In the current market environment where the liquidity of altcoins is scarce, the optimal strategy for market makers when using a call option model is often to sell the project tokens immediately after acquiring them. This practice may raise questions: if the token price rises in the future, won't the market makers have to spend a lot of money to repurchase them?

In fact, this strategy is based on the following reasons:

1. Market makers follow a delta-neutral strategy, do not hold net positions, and pursue stable profits.

2. Call options effectively limit the maximum purchase price and control the maximum risk exposure of market makers.

3. Such market-making contracts usually last for 12 to 24 months, and currently, most projects find it difficult to maintain high prices for a long time.

4. Even if individual projects perform well in the long term, the gains from price fluctuations of cryptocurrencies are enough to offset the losses from early "selling out".

Market Background

Currently, there are three common market maker cooperation models in the market:

1. Renting Market-Making Robots - The project party provides funds, the market makers provide technical support, and charge a fixed fee and/or profit sharing.

2. Active Market Making - The project party provides tokens, the market maker provides funds, and the main purpose is to sell tokens and share profits.

3. Call Option Model - The project party provides tokens, market makers provide funds, but have the right to buy at a low price when the price exceeds the agreed price.

This article will focus on analyzing the most common bullish option patterns.

Typical Market Making Terms under Bull Call Option Model

From the perspective of a delta-neutral market maker, the following cooperation terms are generally provided: ( is usually for 12-24 months ):

Centralized Exchange Market Making Obligations:

• A trading platform: Provides buy and sell orders of $100,000 within a ±2% price range, with a spread of 0.1%.
• Other platforms: Provide buy and sell orders of $50,000 within a ±2% range, with a spread of 0.1%.

Market-making obligations for decentralized exchanges:

• Provide a $1,000,000 liquidity pool on a certain DEX, with 50% in stablecoins and 50% in project tokens.

The project party provides resources:

• Lending out 3 million tokens ( accounts for 2% of the total supply, with a current valuation of 3 million USD, implying an FDV of 150 million USD ).

Market Maker Options Incentive ( European Call Option ):

• Strike price $1.25, quantity 100,000
• Exercise price $1.50, quantity 100,000 pieces
• Exercise price 2.00 USD, quantity 100,000 pieces

Core Strategies of Market Makers

Core Objectives and Principles

• Always maintain delta neutrality to hedge against market price volatility risks.
• Does not bear directional risk; profits do not depend on the rise and fall of token prices.
• Maximize non-directional returns, main sources include: a. Centralized exchange trading price difference b. Decentralized Exchange Liquidity Pool Fees c. Volatility arbitrage achieved through hedging OTC options d. Favorable funding rate

Initial Setup and Key First Step: Hedging

This is the most critical step in the entire strategy, and the actions are determined by the received assets and the obligations undertaken, rather than by predicting prices.

Asset and Liability Inventory:

• Received 3 million tokens (, which is also a future liability to be repaid ).
• Market-making obligations require the deployment of 700,000 tokens and 700,000 USDT

Initial Net Exposure Calculation:

• Need to immediately sell 700,000 tokens to exchange for the required USDT
• The remaining 1.6 million tokens are unhedged long positions.

Initial hedging operation:

• Immediately sell a total of 2.3 million tokens on the market
• 700,000 pieces used to exchange for USDT needed for market making.
• 1.6 million pieces used to hedge remaining positions

This move can meet operational needs, achieve true delta neutrality, and lock in risks. Market makers will not hold any unhedged tokens waiting for the price to rise.

Dynamic Hedging: Continuous Risk Management

After initial hedging, continuous dynamic adjustments are required to respond to market making activities and market changes:

• Centralized exchange market making hedge: Short an equal amount of perpetual contracts when buy orders are filled, go long when sell orders are filled, to profit from the price difference.
• Decentralized Exchange LP Hedging: Continuously calculate the delta of LP and hedge it in the opposite direction using perpetual contracts.

Options Strategy: Profit Core

This is the most exquisite part of the entire transaction and the key to achieving excess profits.

Understanding the value of options:

• The holdings are three levels of call options, with positive delta and positive gamma.
• The value of options increases during price rises, and the more volatile the fluctuations, the more favorable it is.

Hedging Options:

• Calculate total delta using option pricing model
• Short the corresponding quantity in the perpetual contract market to achieve neutrality.

Gamma Scalping:

• Continuously adjust hedge positions in response to price changes
• Profit from each fluctuation by "selling high and buying low"
• Earn volatility rather than directional returns

Operations near the strike price:

• Increase hedging shorts when the price approaches the strike price
• Execute the option when exceeding the strike price, immediately sell to gain arbitrage.

Conclusion and Operational Recommendations

1. Initial token handling: Immediately sell 2.3 million tokens, 700,000 for operations, 1.6 million for hedging.

2. When the price is below $1.25:

   • Do not actively buy or sell non-hedging tokens
   • Continuously engage in market making, LP hedging, and options gamma scalping
   • Profit comes from price differences, fees, and volatility

3. When the price is higher than the exercise price:

   • The hedging engine has established the corresponding short position.
   • Exercise to become a risk-free delivery: buy at a low price, sell at a high price, and simultaneously close out to hedge the position.

This strategy breaks down complex market-making protocols into quantifiable, hedgable, and profitable risk-neutral operations. The success of market makers relies on excellent risk management capabilities and technical execution, rather than market predictions.

After understanding these, we can see that market makers do not intentionally "dump" but make rational choices under the existing mechanisms and algorithms. The market is brutal and precise, and seemingly favorable terms often hide complexities. It is crucial to maintain a sense of reverence for the market algorithm.