Why is loan-based proprietary trading still predominant?

Despite its inherent risks and potentially much higher costs, the proprietary model has valid use cases.

Choosing between Market Making as a Service (MMaaS) and proprietary trading is about resource optimization.

The central dilemma: capital efficiency vs. cash flow

Besides their incentive structures, the key difference between the two models is the working capital requirements, the funds needed to start market making. 

The proprietary market making model has lower working capital requirements: a crypto project only has to lend their tokens to the market maker. The market maker, in turn, takes care of providing the collateral for the market pairs. 

The project or community does not receive any interest on this token loan. Most of the time, the service contract allows market makers to sell the tokens at a predetermined price. This is where the conflict of interest might arise between the client and the service provider.

This arrangement makes the proprietary model potentially highly inefficient financially.

Contrastingly, the MMaaS model requires

• paying a fixed, regular service fee, and

• the token project adding its own collateral.

This can turn out to be a much better value in most of the cases. 

MMaaS does not only give token projects full control over market making strategy. They get to keep the ownership of their tokens and the collateral — as well as all the profits and losses (P&L) of market making. The MMaaS provider gives operational and trading support to its clients. They choose, shape, and implement the right market-making strategy together, in constant consultation.

Who chooses proprietary trading over MMaaS?

Projects with low capital

Because of the high working capital requirements of MMaaS, projects whose capital is scarce may have a hard time affording it.

But as proprietary market makers are taking the risk of providing the collateral they prefer tokens whose price could quickly increase. If they see no such potential, proprietary traders can ask for an even heftier “price”: larger, riskier token loans or not provide market making services at all.

However, early-stage projects and communities with low capital that still want to use MMaaS can find ways of funding (like selling their tokens to obtain collateral).

Well-funded projects

Why do larger projects sometimes choose proprietary trading over MMaaS?

They usually have no problem with fulfilling the working capital requirements. Yet, they may optimize differently. It may be easier for them not to get involved in selecting and setting market making strategies.  They might prefer using another precious resource, time, for other purposes.

For tokens with higher market capitalization, the risk calculus may also look different.

High market capitalization usually means higher market liquidity for the token. Hence a single market maker alone is much less likely to impact the token’s price alone. So to minimize operational risks and diversify their liquidity sources, projects with ample capital might choose to work together with multiple market makers.

Why MMaaS comes out on top for the overwhelming majority of crypto and web3 projects

Aside from the marginal cases of projects with “scarce” and “abundant” capital, the majority of crypto projects and communities are better served by MMaaS.

Ultimately, their choice is all about capital efficiency. The increased transparency and control over market making strategy and activities further add to the advantage of MMaaS. These help token issuers grow faster, with lower risks in the long run.

In this sense, the investment MMaaS requires is essentially an insurance policy.

Flowdesk and proprietary market making: raising the standard of transparency in crypto

Flowdesk believes that MMaaS is superior to proprietary trading in the vast majority of cases. It delivers better outcomes by design.

Proprietary market making may still make sense in a few qualified cases. This is why Flowdesk also provides proprietary market making solutions upon request.

As a compliant Digital Asset Service Provider registered with the financial market regulator of France (Autorité des Marchés Financiers, AMF), Flowdesk conducts proprietary market making as transparently as MMaaS. It is Flowdesk’s guiding principle and legal duty to never trade against our clients.

We are committed to raising standards in crypto. Flowdesk’s mission is to “transform the crypto financial industry by bringing more transparency and control to token issuers over their financial needs”. Because a better economy is possible only if the fundamental values of blockchain technology and laws are respected.