Market making in traditional markets

I just got off a call with a mate of mine from my energy trading days and we were discussing market making on exchanges.

He said he knows of a company that spent almost a year negotiating a fairly straight-forward arrangement (governed by a business contract) to provide liquidity on some markets for a fairly major exchange. I just think about all of the person-hours that went into that negotiation - traders and lawyers aren’t cheap!

In any case, the main points of their negotiation for a market making contract were:

  1. Obligations - typically structured as placing volume at a contractually agreed maximum bid/ask spread (%), with negotiation around how “often” you need to supply this volume, including specification of whether you need to refresh prices after they trade.
  2. Penalties - there’s an option to choose whether to be a “voluntary” market maker, which means that you don’t get penalised if you don’t provide liquidity. Otherwise, your rewards will be reduced.
  3. Incentives / rewards - structured as fee rebates - which basically means you’re not “earning” money, you’re just paying less for using that market for other strategies.

So I am sure I should be able to answer this! but I’m assuming Vega is going to be able to improve on that process but I’d love to hear in your words (given you are designing it with the team) what the improvements would be …


Hey @rebecca, that’s a big question! I’m going to try and summarise it, but there’s a lot more to say on this side of our design as it’s a really big part of what we’re thinking about in terms of how markets should work. In fact, we’ve literally today just finished an internal first draft of a paper we’ve written on this very topic, which I’ll make sure to share here soon!

So, there are 3 main bits of the process that we have addressed, that benefit both traders of the market and those who are in the business of liquidity provision.

  1. OPEN TO ALL: Lengthy, opaque negotiations don’t seem sensible in the current interconnected world of trading. Vega’s protocol (and eventually the open source code implementation) allows anyone at all to join and participate in market making. At all points in time, it will be clear what the obligations and rewards structures are - so, this is not a 12 month negotiation behind closed doors - provision of liquidity becomes everyone’s choice.
  2. WAY MORE MONEY IN IT: Rewards for provision of liquidity are traditionally in the form of fee rebates. That’s not the case on Vega. In fact, price makers don’t pay to trade, so market makers aren’t going to be paying any fees when someone hits their prices. Actually, what happens is that being a market maker on Vega is seen as being a part owner/operator of the market and therefore market makers get an equity like revenue stream derived from the fees charged to price takers of the market (these fees are also shared with infrastructure providers). Even better, if you provide early liquidity to a new market that then becomes really successful, your earnings are significantly compounded. We’ll be sharing more details and some modelling of that pretty soon, too!
  3. RESPONSIVE / EFFICIENT FEE STRUCTURES: The rewards that a market makers earns essentially represent the value of liquidity provision to that market, and since this varies over time (and on derivatives markets according to how much open interest exists). As such, we have made the reward level (which is driven by the fee price) also vary. There are different ways to set the fee level and in our new paper we explain a bunch of these :slight_smile:

There’s plenty more explainers and models to come on this side of things! Thanks for the question :smiley:

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Cool - thanks for that … love the summary but you are right, there is heaps of information behind all of that. Probably not in this post, but over the next few weeks I might dig in further to lots of these topics with various members of the team … you’ll be first on my list to hit up for a chat :wink: