Is every cryptocurrency a pump and dump scheme? Many people ask this question about

Is every cryptocurrency a pump and dump scheme? Many people rightly ask this question, because one of the common themes that users notice almost every time a token is listed on a new exchange is a massive, unsustainable rise in price, followed by a seedy collapse, letting the participants hold the bag.

Who is behind the curtain? The answer lies in market makers, companies retained by cryptocurrency projects to manage tokens (or liquidity) initially used for trading when they are listed on new exchanges.

Primary lists in cryptography

The transition from the private to the public market through initial listings of digital assets is similar to an initial public offering (IPO) in traditional stock markets, with one important difference: the opening price of the digital asset market is often intentionally undervalued by digital issuers. assets. , which translates into significantly better first-day performance than traditional markets.

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In traditional markets, passive investors primarily hold stocks, while in digital asset markets, tokens are ideally held by active participants. The success of the token market depends on the power of its holders. Unlike IPOs, where investment banks set offering prices, token prices in IPO rounds are often lower than the fair market price, leading to increases in token prices on the first day in digital markets.

During the initial listing, the market maker – or MM – takes a large percentage of the circulating supply of the token and puts it up for sale. This is done via the exchange’s pre-market order book, allowing MM to position liquidity ahead of public trading. The objective is to ensure sufficient liquidity for efficient price discovery when the market opens.

However, some MMs undercapitalize order books to inflate short-term profits, which is detrimental to the token community and the project. This practice, known as “parasitic” market making, prioritizes the profits of the MM over the health of the market.

Below are the different approaches to providing liquidity for the initial listing by creating pre-market orders.

  • Parasite: The MM parasite exploits prerequisites for commercialization by creating artificial scarcity and manipulating sentiment. They wait for retail bids to increase, then aggressively sell the token, placing high sell orders to meet demand, causing the token’s price to fall. This harmful strategy exploits initial demand, often causing irreversible damage to the market.
  • Of transition: The MM parasite manipulates the pre-market order book, placing massive sell orders to fill their positions and maximize fees or close OTC trades. This approach results in a rapid exit from the market, removing the potential price rise by selling the token en masse.
  • Symbiotic: In turn, risk management uses its understanding of the pre-market order book to strategically implement opening liquidity, create long-term value, and ensure accurate price discovery. By providing liquidity on both sides, MM facilitates the regulated price discovery process that reflects the true market value of the asset.

To rank market makers based on their approach, we tracked the price performance of several tokens over two critical periods: the first two days after listing (analyzed hourly) and the first two weeks (analyzed daily). This data, obtained from the trading platform underlying the project or from trusted aggregators, is subject to standardization for comparative analysis between different projects. At the heart of our analysis was relative change in volatility (RCV), a methodology we previously presented in a case study.

The formula for relative change in volatility, or RCV. Source: Asheron Trading

The RCV formula measures the change in volatility with and without a token’s highest price (ATH). If the value is positive, it means that the order book was insufficient, indicating insufficient pre-market liquidity. A negative value indicates an excess order book, which indicates strong market making – and overvalued assets. A neutral value means that liquidity is suitable for orderly price discovery.

To evaluate initial listings and the MM approach, we applied the RCV methodology to 93 listings from April 2024 on Bybit, Kucoin, Binance, Coinbase, Kraken, and OKX.

Breaking down the pre-market list approach. Source: Asheron Trading

We found that 69.9% of initial registrations were classified as “parasitic”, while 8.6% were “transient”, leaving only 21.5% following the “symbiotic” approach. This means that 78.5% of launches were carried out in a way that disrupted the determination of the right price, which had a negative impact on both end users and the projects themselves.

For spurious launches, including the ATH point, this translated into a 420% increase in market volatility, indicating severe supply shortages and price inflation leading to market abandonment. Conversely, transit launches showed a 34% drop in volatility when including ATH, indicating an oversaturated backlog where initial supply was mismanaged, only benefiting MM at the expense of the community.

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Parasitic and transient approaches significantly harm price discovery, thereby reducing the likelihood of sustainable market participation. In contrast, symbiotic methods yielded an RCV of approximately plus or minus 20%, providing a stable basis for fair and sound pricing processes.

As the digital assets industry continues to grow in legitimacy and size, it is imperative that market makers address the massive mismanagement of primary listings. Asset issuers and exchanges should engage market makers – and use the RCV methodology – to analyze whether market makers structure initial order books appropriately.

Market makers have a terrible image, and as the data indicates, for good reason. It’s time to raise the bar, get rid of parasitic traders, and hold market makers accountable for their essential role in effective price discovery. Our industry deserves it.

Wesley Prior He is a guest author at Cointelegraph and founder of Acheron Trading. He worked as a senior advisor at PwC before becoming a partner at Ænigma Capital and has been an advisor to companies and projects including Hxro Games, CasperLabs and Geeq. He holds a bachelor’s degree in business administration and a graduate degree in accounting from Florida Atlantic University.

This article is intended for general information purposes and is not intended and should not be relied upon as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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