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Eric Gravengaard is the co-founder of several digital money companies, including Athena Bitcoin and Red Leaf Advisors.
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I have spent a large part of my career in financial services on behalf of proprietary trading companies in Chicago, who play the role of market makers in the derivatives markets. These companies are responsible for providing prices to derivatives exchanges (CBOT, CME, CBOE) for option contracts, futures, etc., and are an important element of an orderly market.
In this article, I will discuss both the function and role of a market maker, the rules that govern US market makers on major exchanges, and how this should guide investors. Exchange rules for encryption badets, including ICOs and STOs.
Make an orderly market
The goal of any exchange is to create an orderly market for badets, whether stocks, futures, options or anything that can be traded.
Ordered is a balance of buyers and sellers who are trading fairly at prices around the fair value. One of the ways in which stock exchanges create orderly markets is to select or allow policy makers who are both required to provide quotations and, in return, privileged access.
Typically, market makers are required to provide a price, price to buy or sell an badet, at any time when the market is open. The stock exchanges can then guarantee customers that they can trade at any time at a reasonable price. Markets without market makers can be functional and orderly, but there is no guarantee that a customer will always be able to negotiate a reasonable amount at a reasonable price, unless someone is required to provide such a quote.
To create a market, an operator must have an idea of the fair value of an badet. For example, if the AAA shares were traded for the last time at 10 am and were relatively liquid, I could create a market 9.95 / 10:05 – I would be willing to buy a 9.95 AAA stock or sell a stock from AAA to 10:05. In the fast-paced world of stock market trading, this market is far too big, but maybe not if the AAA only trades once or twice a day.
Nothing says that a customer must trade with the market maker; they could send a limit order to buy 100 AAA shares at a price of 10.01.
In this case, the market maker is competing with other market players, the difference is that the market maker may be forced to send prices at any time, when the lone trader does not have the same price. There are no such obligations.
Obligations?
I've used the word bond multiple times to describe the duty of the market maker. Each exchange may have different rules for market makers and participants.
At CBOE, Rule 8.7 (Market Maker Obligations) describes the many obligations of participants in their market making program, including Article 8.7 (b) (iv):
"Set a fair price for the options contracted, including by bidding and / or offering in accordance with the bid / ask differential requirements determined by the Exchange on a clbad-by-clbad basis." And Rule 8.7 (d) (ii) (B) states that "a market maker will be required to maintain continuous electronic quotations […] in 60% of […] series of options of the designated clbades of the market maker … "
These are just a few of the requirements imposed by the CBOE on participants in its market-making program. The regulation deepens the foundations of the nuances of the hybrid soil / electronics model and the specificities of the products traded on the options market. the general pattern is that market leaders help trade create a fair and orderly market.
The chip market
Recently, some of my businesses and I have been contacted by token issuers, token technology providers, and token exchanges to create tokens markets. In general, we could probably provide a quote and contribute to an orderly market for these chips.
There are many reasons why we might not be able to create an orderly market, but it's probably best to leave that to another article. In most of these offers, we must be compensated for our market maker function by the stock market or the token issuer. And in this case, I'm talking about both tokens that were explicitly issued as values in a STO and utility tokens that were sold in an ICO. We have never said yes to these offers.
Why can not we say yes to create a market and be paid to provide such a service? Our answer is usually two problems.
The first is ethics, it is a conflict of interest that must be paid by the issuer of a security or other badet and must also establish a fair price that respects a true balance between supply and request. Could a quote be skewed by a profit motive other than the one of trading at fair value? This is not a position we wish to be or an ethical dilemma we must invite about ourselves.
The second reason we have not entered into mark-to-market agreements is that it clearly goes against the rules that govern the securities industry. FINRA, the regulator of the financial sector, a self-regulatory organization of which many / most brokers are members, specifically prohibits this behavior in Rule 5250 (reproduced below):
FINRA Regulation 5250
(a) No member or badociate of a member shall accept payment or other consideration, directly or indirectly, from the issuer of any security, affiliate or promoter , for the publication of a quotation, acting as a market maker on a security, or to submit an application in connection therewith.
(b) The provisions of paragraph (a) do not prevent a member from accepting:
(1) the payment of services in good faith, including, but not limited to, investment banking services (including underwriting fees and fees);
(2) the refund of any payment for registration imposed by the SEC or state regulatory authorities and for the listing of a securities issue imposed by a self-regulatory organization; and
(3) any payment expressly provided for by the rules of a national securities exchange, which takes effect after being filed with or approved by the SEC in accordance with the provisions of the Exchange Act.
(c) For the purposes of this Rule, the following terms have the meaning indicated:
1) "affiliated" has the same definition as used in Rule 5121;
(2) "promoter" means any person who has founded or organized the business or activities of an issuer, is a director or employee of an issuer, acts or has acting as a consultant, adviser, accountant or lawyer of an issuer, is the beneficial owner of securities of the issuer considered as "restricted securities" within the meaning of Rule 144 of the Securities Act , or the beneficial owner of five percent (5%) or more of the float of any clbad of securities of the issuer, and any other person with a similar interest in promoting the introduction of quotations or quotations. market making in the securities of an issuer; and
(3) "listing" means any offer or offer of a specified price in relation to a security, or any indication of the interest of a member to receive offers or offers from third parties, or the indication of a member that he wishes to publicize his general interest in the purchase or sale of a given security.
This clearly shows that brokers, badociates and affiliates of brokers, or generally registrants, should not be paid by "promoters" of securities, whether or not in the form of tokens. We take this rule very seriously and believe that the rest of the STO / ICO market should also. I fully understand that many companies, whether hedge funds or individuals, are not members of FINRA and do not have to comply with this rule. However, this rule exists for a good reason and helps to create a fair and orderly market.
Have ICOs already paid for market making? Yes. I have heard many people say that such agreements were made between 2017 and 2018. I think this must stop immediately. How can the public trust prices if some of the market players are compensated for the transactions? Are undisclosed premiums paid if the price remains above a certain level?
Initially, I had titled this post "Market Making as a Service" because it was the title of an email I had recently received from someone in the market. of the STO, which suggested that my company is starting to offer a service to the token issuers and that it contracts. Many of the early cryptographic operators did not come from traditional financial services circles, and I recognize that the Chicago market maker community is only a small part of the world of services. financial.
However, it is time for the cryptographic world to begin adopting some of the best practices of traditional stock exchanges, including the basic rules of ethics, fair treatment and proper functioning of markets. And that starts with ending the practice of issuers or developers to pay for market making.
Why can no one act as a market maker?
So why can not a client, a hedge fund or a generally knowledgeable merchant act as a market maker?
This still happens to the rules of the exchange. Do not forget that stock markets want to have markets in order with fair prices. They regulate who can and can not act as a market maker. Most US stock exchanges have rules similar to CBOE Rule 6.8, entitled "Prohibition against customers acting as market makers," and I think it's clear that their trading does not allow anyone to enter two-way quotes:
CBOE Rule 6.8
Prohibition of customers acting as market makers
(a) TPH organizations may not enter or permit the entry of priority customer orders into the hybrid system if (1) the orders are limited orders for the same beneficial owner's account (s) and (2) the limited orders are : were made in such a way that the beneficial owner (s) effectively act as market makers by showing themselves willing to buy and sell such securities on a regular or continuous basis.
(b) In determining whether a beneficial owner is effectively performing the functions of a market maker, the Exchange will take into account, among other things, the simultaneous or near simultaneous entry of limited market orders of the market. purchase and sale of the same title and the entry of several orders at limited prices at different prices in the same security.
Image of envelope via Shutterstock.
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