« Market Making 101: Part 1 February 11, 2020 • ☕️ 1 min read

You buy a Bitcoin for $8000 and sell it for $8010.

You just made a $10.

You keep doing this all day. Buy for $8000, sell for $8010.

At 5 pm, you have sold 99 Bitcoins and made $10x99 = $990.

Let’s make it $1000

You place an order to buy another Bitcoin for $8000, thinking:

“Let me nail this last one and then I’ll go home. $1000 dollar profit, baby.”

A guy named Joe approaches you and says:

“Sure. You can have this one for $8000”.

You hand Joe the $8000 and Joe hands you your Bitcoin.

You then place an offer to sell it for $8010. Like you have done 99 times previously today. “Another $10 of easy money”, you think.

Joe was smarter than you

Right when you have placed the offer, the price of Bitcoin crashes to $7000.

You scowl: “Fuck, why did I do this?”

You just witnessed the adverse selection problem.

Joe was more informed than you. He knew the price was about to crash. You had no idea.

You had been buying and selling all day, making a fat profit.

Now, you’re left with one Bitcoin that you bought for $8000 and which has a market value of $7000.

Your net profit for the day is $990-$1000 = -$10.

Market making seems like free money. Until adverse selection happens, and it’s not.

As a market maker, you need to be prepared for adverse selection.

You need to be able to adjust your bid and your ask (collectively known as your spread) so that adverse selection doesn’t rob you of all of your hard-earned gains.

There are various strategies on doing this.

In the next part of this series we’ll cover a few of them.

Until then, if you’re curious about market making - why not sign up on a trading platform and try it yourself?

Some trading platforms offer you free trading bonuses that you can use to try out market making. This way you won’t risk any money in the beginning.

Other platforms provide live testing environments (paper trading) that you can use to practice your market making for free.

You can do it manually (using your hands), or you can code a bot that will do it for you. Depending on the market, both approaches can earn you money. Which one you choose is up to you.