How liquidity providers add value for their partners and the broader ecosystem in times of market turbulence


Originally published by Callen Van Den Elst on CfC St. Moritz on March 29, 2023.

A number of compounding factors sent crypto markets to a low in 2022, which was only further exacerbated by digital assets being increasingly correlated to traditional markets and negative macroeconomic moves. Additionally, a set of impactful industry-changing events caused a shift in how market participants perceive digital assets. The resulting plunge in crypto prices and corresponding liquidity crunch sent retail investors running for cover, while institutional participants tried to mitigate risk and weather the bear market’s volatility. Furthermore, the fall of one of the biggest players in the space sent shockwaves throughout the system, further shrinking the market and intensifying the downturn.

The current market turmoil has led participants to prioritise risk management over trading opportunities, highlighting the importance of execution certainty that can only be ensured by robust and established liquidity providers. These providers play an integral role in stabilising markets and help ensure markets are resilient, even under the most difficult circumstances. To this end, it is of the utmost importance that liquidity providers create infrastructure that enables access to assets on demand across countless venues. This facilitates all types of trading, especially over-the-counter (OTC) trading, which has seen an influx of activity in the latter half of 2022 as institutions looked to offload risk.

Importance of a Robust Liquidity Provider That Enables Efficient Execution at All Times

With market turbulence comes uncertainty and market liquidity can dry up which forces market participants to manage their risk accordingly and take flight to safety. For a smooth functioning financial ecosystem, it is paramount to have robust market liquidity at all times, especially under stress. To minimize the impact of a significant industry event and general market downturn, liquidity providers need to keep markets active by continuously quoting two-way prices across markets so that trading can always occur. Therefore, having a reliable liquidity provider that has the technical sophistication and knowledge to still be present in times of uncertainty allows for a healthy and sustainable market long-term.

The most crucial measurement of technical sophistication is that providers must possess the infrastructure to source liquidity and supply markets on demand, regardless of the financial environment. When it comes to the efficiency of execution, it is important to understand how many liquidity pools are underlying the execution. To achieve better pricing and trade execution it is necessary for the providers to execute orders across a very wide range of venues, including exchanges, aggregators, as well as centralised and decentralised platforms. Additionally, when liquidity is squeezed it is even more important to understand if liquidity providers have the size and capability to execute the orders in such an environment.

Institutions often require a different, more tailored product offering and ways of doing business than what is available on centralised exchanges. To avoid heightened slippage during low liquidity periods, institutions trading large clips of sizes can significantly benefit from OTC trading where liquidity is readily available. Facilitating trades of large blocks via OTC providers that enable access to institutional-grade product offerings and risk management tools, without an intermediary, allows for maximum trading flexibility. To accommodate for timely and reliable OTC trading, providers must connect to multiple liquidity sources so that they can successfully offer trading of large amounts of assets without moving the market.

Wintermute is connected to a wide range of liquidity pools across the crypto ecosystem, allowing the company to provide liquidity algorithmically to some of the largest trading platforms. To bring further value to its clients, Wintermute leverages the same pricing algorithms used in its proprietary trading business for OTC trading. This allows for the execution of any trade, with competitive pricing, regardless of its size or market conditions.

Protecting Downside Risk With Derivatives by Using Crypto Options as a Hedging Instrument

Traditionally, demand for crypto derivatives products is closely connected to the degree of uncertainty in the market as derivatives offer a flexible method to manage the risk of volatility. The crypto derivatives market saw impressive growth throughout 2022, especially during the volatile periods of the bear market, as institutions looked to minimize their liability by hedging existing positions. Liquidity providers play an integral role in this process, as it is difficult for institutions and treasuries to access proper hedging tools and reduce their risk without deep liquidity.

The demand for derivatives focused mainly on crypto options trading through OTC providers as the liquidity issues and market events caused investors to lose trust in centralised entities that rely on intermediaries. Generally, access to the crypto options space is still somewhat limited due to differing regulatory policies across jurisdictions, meaning that certain exchanges may not be available to all users. To gain access to crypto options markets on a bilateral basis, investors can turn to OTC trading providers. While the crypto options space is still nascent, there has been tremendous growth over the past year as more institutional players are entering with an appetite for more sophisticated products.

Time to (Re)Build

The events of 2022 will cast a long-lasting shadow on the crypto ecosystem. The market turbulence, changes in overall market structure and a massive reduction in liquidity caused a consolidation of an industry that relies on decentralisation. However, the industry is at a turning point. Complex market events are usually predecessors of market recovery, especially when they increase visibility into a space, and often lead to further innovation.

Builders, both new and old, are expected to capitalise on the recovery of the industry and will utilise this opportunity to revolutionise crypto, such as by bringing traditional financial products and services to the decentralised landscape. Crypto’s recovery will only be successful if the liquidity exists to enhance retail and institutional access to the wide variety of tokens and ecosystems, with counterparties involved to efficiently manage risk.