The Need for Institutionalization of Market Makers Between Liquidity Provision and Price Manipulation

An image reminiscent of market makers. Source=ChatGPT

1. Why are market makers perceived as 'forces' in the digital asset market?

Anyone who has experienced the cryptocurrency (digital asset) market is familiar with a certain situation. Prices that show a sharp rise immediately after listing suddenly plummet, and the previously abundant trading volume disappears in an instant. Digital asset investors often point to market makers (MM) as the culprits behind these price fluctuations.

This negative perception stems from companies that manipulate prices under the guise of market making. Due to such companies, the meaning of market makers has been distorted to signify price manipulation forces in the digital asset market, leading to continuous investor losses in the global market as well.

In fact, the FBI in the United States has prosecuted companies engaged in 'service-based price manipulation', and in South Korea, a group that manipulated trading volume under the pretext of providing liquidity has been sentenced to prison. However, these are illegal companies that simply transfer quantities for a fee and do not fulfill the original role of market makers. The lack of clear qualification criteria has led to the indiscriminate use of the name market maker, ultimately undermining the trust of the entire industry.

Such price manipulation activities not only break market trust but are also unrelated to the true role of market makers, who should provide liquidity.

2. Reasons why market makers are needed in the market

Market makers are key participants who provide liquidity by simultaneously presenting buy and sell quotes and facilitating transactions. It is necessary to summarize their roles to understand why they are needed. In South Korea, the term 'liquidity provider (LP)' is widely used alongside 'market maker'.

Broadly speaking, liquidity provision is not a task limited to companies with specific qualifications. Orders that remain on the order book waiting for a counterparty (maker orders) are all creating trading counterparts for other investors. Therefore, any participant placing maker orders is, in a broad sense, providing liquidity. High-frequency trading (HFT) firms like Jump Trading, which fill the order book with their own funds, also fall into this category.

Just as airport currency exchange counters guarantee exchanges at any time, markets with market makers do not require buyers and sellers to wait for each other. This benefit extends to both investors and token issuers.

2.1. What investors gain: Reduced transaction costs

The actual profit and loss for investors is not determined solely by fees. More important are the 'hidden costs' such as whether orders are executed immediately at desired prices, whether large transactions cause price fluctuations, and whether there are price differences between exchanges.

What market makers do is ultimately meet these three conditions. They place tight quotes on both the buy and sell sides, stand on the opposite side even when there is no trading counterpart, and adjust prices that have occurred between exchanges. As a result, investors can trade at similar prices when they want, with lower costs.

Reduced transaction costs: Narrowing the difference between buy and sell prices (spread), reducing additional costs for large orders.

Trading when desired: Always securing a counterparty for buying and selling.

Narrowing price differences between exchanges: Simultaneous quoting on multiple exchanges, price convergence through arbitrage.

First, transaction costs decrease.

The difference between the buying price and the selling price (spread) is also a cost. If the price to buy immediately is 1010 won and the price to sell immediately is 990 won, reselling right after buying incurs a 2% loss. The loss increases with larger orders. After buying all the quantities at the first price, one must move to the next price, and so on, leading to progressively higher costs. When market makers place tight quotes, this difference narrows, and the quantities at each price level increase. Consequently, the losses seen during trading decrease.

Second, trading can occur when desired.

In investing, it is crucial to be able to enter and exit at the desired moment. Tokens with low trading volumes require sellers to wait for buyers to appear, during which time prices continue to fluctuate. Market makers consistently place quotes and act as trading counterparts. Therefore, even during times when trading is sparse, sellers can find immediate buyers, and buyers can purchase without waiting.

2.2. What token issuers gain

For token issuers, listing is not the end but the beginning. Tokens must continue to be traded after listing for users and investors to come and go, and for the tokens to be recognized at their true value. Market makers help maintain this market. Token issuers gain two things through market makers.

Ensuring consistent trading: Mitigating significant price fluctuations even with small orders.

Preventing suspicion of price manipulation: Quote management is handled by independent market makers, while token issuers only lend quantities.

First, they obtain a market where tokens are consistently traded. Listed tokens are evaluated daily in the market. Users buy tokens to use services, and investors buy and sell based on potential. For these participants to come and go without burden, tokens must be recognized at their true value. Tokens with low trading volumes experience significant price fluctuations even with small orders, and such volatility increases anxiety and damages the reputation of the token issuer, regardless of the issuer's actual performance.

Second, they can avoid suspicion of intervening in prices. If a token issuer buys and sells its own tokens directly, it is easy to be suspected of manipulating prices. Therefore, trading is entrusted to independent market makers, and token issuers only lend quantities. Normal contracts also include clauses to prevent price manipulation.

In summary, investors can significantly reduce the trading costs they bear while executing trades in a timely manner, and token issuers can create a trading environment where assets circulate stably. The bid-ask spread that market makers receive is a kind of service fee borne by market participants wishing for immediate transactions. Only when these transaction costs are gradually reduced through autonomous competition in the market will all members of the ecosystem benefit.

3. What is different about digital asset market makers?

The work of digital asset market makers is not different from that of traditional financial market makers. However, the difference lies in the regulations of the markets and countries in which they operate. Stock market market makers work under refined systems with official contracts with exchanges. In contrast, there is currently no system in the digital asset market to handle contracts between market makers, exchanges, and issuers.

3.1. Who does it?: Traditional market makers are licensed financial institutions, while digital assets have no contractual qualification requirements

In traditional finance, market makers have a clearly defined official role by law. Financial institutions that pass examinations formally contract with exchanges and receive benefits such as reduced fees in exchange for submitting quotes as promised. Exchanges transparently disclose who the market makers for which securities are, and long-standing laws and precedents have established clear criteria for what constitutes 'normal market making'.

However, the situation is entirely different in the digital asset market. While the work of market makers is the same, there is virtually no 'framework' in which market makers formally contract with exchanges and exchange obligations and rewards.

The decisive differences between the two markets are twofold.

First, there is a lack of rules regarding contracts. There is no established framework for what constitutes normal market making, who can become a market maker by contracting with an exchange, what obligations they have, and what rewards they receive.

Second, there are structural risks unique to the digital asset market. It is common for exchanges to take on the role of market makers directly, or for market makers to secretly enter into contracts with coin issuers. Given this situation, major financial authorities around the world are focusing on extinguishing immediate fires, such as preventing exchanges from operating market makers and demanding transparency in secret contracts, rather than creating entirely new systems from scratch.

The South Korean market faces the same challenges. While exchanges are strictly prohibited from acting as market makers, there is still a lack of criteria or formal procedures to determine what constitutes proper market making.

It is important not to misunderstand this point. The absence of rules pertains to the official contracts that market makers enter into with exchanges or securities firms. This contract is where licensing is required. The act of placing bids and trades with one's own funds is already a legal activity, regardless of licensing. The EU MiCA also does not require a license for market making with one's own funds within an exchange, only imposing requirements when providing services to customers.

3.2. Who and what contracts are made?: Tradition with exchanges, digital assets with token issuers

The most noticeable difference between digital asset market making and traditional finance is the prevalence of contracts with token issuers.

Among these, the 'contract-free self-capital type' is different in nature. It does not enter into contracts with anyone and does not receive compensation. It trades according to its own strategy with its own funds, and liquidity arises as a result. This falls under the broad definition of liquidity provision and is a legal activity that does not touch on licensing. The token lending type also shares the essence of self-capital trading if the market maker bears the trading judgment and price risk directly without the issuer directing individual trades.

The problem arises with contracts among issuers that measure performance by trading volume. According to industry insiders, these contracts differ from exchange-led contracts in terms of funding sources and risk-bearing entities, covering a wide range from spread setting to strategies for responding to listing and lock-up release points. However, contract structures that take trading volume as the main performance indicator carry a high risk of inducing wash trading, and the fact that the contract details are not disclosed externally is a major limitation.

3.3. In what markets are trades conducted: Traditional finance is a single market, digital assets are fragmented markets

Stocks are traded at a specific time on a single exchange, and exchanges and clearinghouses prevent price volatility and settlement risks. Digital assets are fragmented across exchanges worldwide, operating 24/7, and there are no mechanisms to mitigate these risks. This fragmented liquidity provision poses a risk factor for market makers.

First, the 24/7 digital asset market is divided among numerous exchanges worldwide, leading to frequent price imbalances. Market makers spread their assets across multiple exchanges to correct these imbalances, but if network disruptions such as withdrawal and deposit blocks occur, this market adjustment function can be paralyzed in an instant.

The extremely limited means to hedge risks is also a problem. Without safety devices like circuit breakers and rampant high-leverage futures trading, market makers take opposing futures positions to prepare for price fluctuations.

As revealed during the $19 billion chain liquidation incident on October 2025, when the exchange's automatic debt reduction (ADL) system operates, even the normal hedge positions of market makers can be forcibly terminated. As they lose even the minimal defense, the shock and chaos in the market escalate uncontrollably as they hastily withdraw their bids.

Above all, the fundamental issue lies in the lack of a central clearinghouse (CCP) in the settlement structure. Unlike the traditional financial system that guarantees trades and settlements, digital asset market makers must trade while directly depositing assets at each exchange. Therefore, if an exchange collapses, like FTX in 2022, market makers face a critical crisis where they cannot recover any of their assets and incur total losses.

4. Five Limitations of the Current Market Maker Industry

The role of market makers is essential for smooth asset trading. However, if indiscriminate market-making activities are left unchecked, the stability of the market can be significantly compromised. Now is the time to accurately diagnose the structural problems facing the digital asset market and find practical solutions.

The five limitations discussed in the following section are not defects of the market maker function itself. These issues arise because there are no clear criteria or monitoring systems to distinguish between normal liquidity provision and illegal market manipulation. Ultimately, current digital asset market makers must establish proper standards in the market.

4.1. Normal risk management is misunderstood as market manipulation

Normal risk management activities of market makers can easily be misunderstood as market disruption or manipulation from an external perspective. Industry insiders have identified four representative risk management activities that are prone to misunderstanding.

If what is normal is not defined, such misunderstandings can occur even in regulated markets.

A representative case is the South Korean stock market. In 2021, when the Financial Supervisory Service deemed the frequent bid corrections and cancellations by nine securities firms' market makers as market disruption, it notified them of a fine of 48.7 billion won, leading to an immediate halt in market making. About a year later, in July 2022, the Securities and Futures Commission concluded that corrections and cancellations were unavoidable for compliance and risk management, and that the correction and cancellation rates (95.68~99.55%) were similar to those of the New York Stock Exchange (about 94.6%), and there were no prior criteria, leading to a no-charge conclusion. Although it was not illegal, the market operated without market makers for a year until the conclusion was reached.

In the digital asset market, there are no clear criteria, leading to legal disputes between liquidity provision and market manipulation over the same trades. Even normal market makers cannot predict the legality of trades, resulting in their exit from the market.

The solution is to establish criteria for normal activities in advance. The criteria should be based not on simple cancellation frequency but on the intent to execute trades, which aligns with the approach taken by the U.S. during the 2010 flash crash, where only extreme price bids were prohibited. In practice, compliance with contracts and risk management regulations, actual price risk reduction, and the purpose based on two-sided bids are core criteria.

• Was it executed within the pre-established contracts and internal risk management regulations?

• Did the activity actually reduce the market maker's price risk?

• Was it conducted based on two-sided bids without the intent to push prices in one direction?

For example, if the market fluctuates sharply and one sells the spot while buying the same amount of futures, it may outwardly appear as a selling pressure, but it is a normal hedge that offsets the overall position's risk. In contrast, selling a large amount of spot without hedging while spreading negative rumors is hard to view as risk management. If supervisory authorities and exchanges publicly announce such criteria in advance, normal suppliers can operate without legal uncertainty, and illegal activities can be more clearly filtered out.

The problems arising from the absence of criteria do not end with normal firms being suspected. Conversely, it also becomes easier for non-market maker firms to masquerade as market makers.

4.2. Market Manipulation by Non-Market Makers
If the previous issue discussed the problems of legitimate market makers being suspected, there is also the issue of non-market maker companies posing as market makers. Many incidents that the market remembers as "mistakes of market makers" are actually cases where entirely different businesses operated under this name.

Gotbit is a representative example. According to U.S. prosecutors, Gotbit sold a service that inflated trading volume through a program that repeatedly bought and sold between multiple accounts from 2018 to 2024. The goal was to raise the digital asset market cap ranking of customer tokens and get them listed on major exchanges. The founder pleaded guilty and was sentenced to eight months in prison, and the company had approximately $23 million worth of digital assets confiscated.

Current market makers pointed out that their business model was fundamentally about creating fake trading volume without bearing price risk. In a market that only looks at trading volume, such companies may appear to be performing well.

Therefore, the criteria for evaluating market makers should change from trading volume to whether actual trades can be executed. Trading volume can be inflated through wash trading. Current market makers only reference trading volume as a result and instead look at the following:

• How thick are the orders within 1-2% of the current price?
• How much does the price drop when trading a certain amount?
• How long are both buy and sell orders placed simultaneously?

Even if trading volume appears abundant, if the order book is thin and minor orders significantly shake the price, there is a lack of actual liquidity. Ultimately, the key criterion is whether external participants can smoothly execute their desired quantities at reasonable prices. When exchanges and issuing entities carefully select market makers based on these essential evaluation factors, fraudulent companies that only aim for illegal price manipulation will gradually be eliminated from the market.

Registration or approval can be required from companies that enter into contracts with exchanges or issuers and sell services under the name of market makers. Companies like Gotbit, which sold services for money from issuers, can be filtered out from the outset by setting requirements at the contract stage. There is no need to bind participants who trade with their own funds to approval. As seen in Chapter 3, the EU MiCA also requires licenses only for customer-facing services, not for market making with one's own funds within exchanges.

4.3. Distorted Interests with Unclear Contracting Parties

Even if capable companies are selected, if the structure of who contracts with whom is opaque, critical problems can arise. In the digital asset market, the contracting parties between token issuers and market makers are often not clearly revealed. Because the counterparties in transactions are thoroughly shrouded in mystery, a bizarre structure can emerge where one company acts as an agent for both sides of a transaction.

The case of Movement is an example. The Movement Foundation entrusted 66 million tokens, which is 5% of the supply, to the intermediary company Rentech, which claims to be a subsidiary of Web3Port, for liquidity provision. However, it was revealed that Rentech appeared as the foundation's agent once and as the Web3Port agent once in the contract. This means the same company was on both sides of the transaction.

This volume was dumped into the market shortly after listing in December 2024, with almost no buy orders. Binance expelled the market maker and froze $38 million in profits. Coinbase subsequently halted MOVE trading. The foundation stated that this sale occurred without their consent. Although it was named a liquidity supply contract, what actually happened was a unilateral disposal of the token issuer's volume rather than a two-way quote.

Therefore, the key to proper market making lies in fair contract terms and transparent contractual relationships.

First, let's look at the content aspect. Contracts of normally operating market makers have two solid principles. Market makers bear actual price risk, and token issuers do not interfere with the market price.

In the case of token lending, market makers provide two-way quotes with borrowed tokens and their own funds. After the contract ends, they simply return the same quantity without receiving any instructions on which direction to lead the price. To ensure this, the contract must include the following essential items:

• Prohibition of wash trading
• Prohibition of actions that lead the price in a specific direction
• Upper limit on the price difference between buy and sell
• Minimum quote volume

Even in call option contracts, if market makers set their own routine quotes and token issuers only set option conditions without directing individual trades, the same principles are upheld.

Next is making contracts visible. At a minimum, exchanges and regulatory authorities should be able to verify which market makers are involved with what volumes and conditions, and whether intermediaries are not representing both sides simultaneously. This is the information Binance will require from token issuers starting in March 2026. Furthermore, just as exchanges disclose market makers for specific stocks in the stock market, investors should also be able to know which market makers are involved.

4.4. Exchanges and Market Makers Under One Roof

If market makers are affiliates of exchanges, the conflict of interest increases. If one company operates an exchange, custody, and proprietary trading, affiliate market makers are likely to receive privileges not available to other users.

FTX and Alameda Research are representative examples. Alameda acted as a major market maker for FTX and received credit limits and privileges not available to other users. U.S. authorities determined that FTX customer deposits flowed to Alameda to cover investments and losses. The two companies went bankrupt together in 2022. The problem was not the status of being a market maker itself. It was that the credit and discretion attached to that status were used to misappropriate customer assets without any oversight.

Thus, the solution is not to outright ban affiliate market makers, but to separate and monitor organizations. The International Organization of Securities Commissions (IOSCO) identified this conflict of interest as a key issue in its 2023 recommendations, and Hong Kong has translated this into a system. The Hong Kong Securities and Futures Commission (SFC) allowed market making by exchange affiliates starting in February 2026, with three conditions:

• The market making organization must be functionally separated from the exchange.
• Clear operational boundaries must be established between the two.
• Before starting market making, an inspection report from an independent professional organization must be submitted to the authorities.

This is a way to draw lines and monitor to prevent privileges and information sharing. If domestic exchanges engage in market making through affiliates or related companies, the same principles should be applied from the outset.

4.5. Market Makers Without Obligations Exit First in Crises

While the previous four cases illustrate the limits of ordinary situations, the last item reveals problems that emerge in markets that are experiencing extreme declines.

Most digital asset market makers have no mandatory obligations to uphold in declining markets. When losses accumulate, the judgment to withdraw quotes acts as a rational response, leading to order voids and causing the market to collapse rapidly. The incident on October 10, 2025, is a representative example. At that time, many digital assets plummeted by 40-70%, and industry insiders assessed that the withdrawal of quotes by market makers was a decisive background to this collapse.

To prevent exits during a crisis, clear obligations and appropriate incentive structures must accompany them. In fact, entities adhering to mandatory norms exhibited entirely different behaviors even amidst crises. According to interviews with industry stakeholders, in the case of certain digital assets that plummeted due to macroeconomic adversities, market makers temporarily widened the buy-sell spreads while maintaining order placements to prevent trading disruptions. This difference stemmed from compliance with contractual obligations and risk management guidelines.

Traditional stock markets have institutionalized such mechanisms. The Korea Exchange imposes an obligation on market makers to submit orders of at least 80% daily and 90% quarterly for specific target stocks, providing incentives only to those who comply. Penalties are imposed for non-compliance, and exceeding a certain threshold results in contract termination and a one-year disqualification.

A standard for measuring compliance is also necessary. Current market makers judge recovery after market shocks not by price rebounds but by whether trading functions have resumed.

• Is the gap between buy and sell prices narrowing again?
• Are the previously missing order volumes being replenished?
• Are the price differences between exchanges converging?
• How long does it take to return to normal?

If these indicators are used as compliance criteria and compensated accordingly, market makers will have more reasons to stay during crises than to leave.

5. From Target of Regulation to Subject of Management

The distrust towards market makers in the domestic market is not unfounded. However, as seen in Chapter 4, following the basis of this distrust reveals that the issue does not lie with the function of market makers. Anyone can claim to be a market maker, and no one has defined what is normal in this structure.

Domestic law still leaves this structure intact. However, it is essential to pinpoint where the gaps are. Activities that involve trading with one's own funds and filling orders are still legal. The same applies to cases where tokens are borrowed for operation. Such activities can be punished if they constitute market manipulation like any other trading, but simply trading with one's own capital does not pose a problem. The gray area lies outside of this, in the contractual aspect.

• There is no channel to establish official contracts with exchanges. The current digital asset user protection law prohibits market manipulation without providing exceptions for market making. Therefore, if an exchange enters into a mandatory order contract with a market maker, the trades under that contract risk being treated as market manipulation.

• There is no licensing or registration system for contractual market makers.

• It is difficult for corporations to open accounts and trade on domestic won exchanges.

Ultimately, what lies outside the system domestically is not the liquidity provision activities themselves, but the channels to officially contract and manage them. Contractual market makers have no way to be managed within the system, and only post-facto regulation remains. Major countries are already restructuring their systems to align with this trend. Regulations on unfair trading are being raised to the level of traditional finance, creating a framework within which market participants can operate.

EU: As of December 30, 2024, when MiCA is fully implemented, market manipulation of digital assets will be prohibited. Market making with one's own funds within exchanges is not subject to licensing. Licenses are attached to points that provide services to customers. Major market makers like Keyrock and Flowdesk received licenses in June 2026 for customer service purposes.

Hong Kong: Reporting a lack of liquidity in exchanges, market making by exchange affiliates was allowed in February 2026. Instead, market making organizations were required to be separated from the exchanges.

Japan: In July 2026, a revised bill regulating digital assets as financial products was passed, introducing a new prohibition on insider trading.

Although the starting points for major countries differ, they clearly share the same direction. Unfair market manipulation practices are strictly regulated to the level of existing financial sectors, while sound liquidity providers are justly recognized within the regulatory framework.

The challenges that the domestic market should aim for also lie in seeking this balance point. Unconditional distrust or blind advocacy towards market makers cannot be a desirable solution. The required direction for institutional reform to improve the structural limitations mentioned earlier is summarized as follows.

The criteria that distinguish normal from deviant behavior should be enshrined in law. It should start from the standards already used in the industry. Whether market makers bear price risks directly, whether they have no intention of pushing prices in one direction, and whether external investors could actually buy and sell. Having criteria in advance ensures that normal risk management is not misinterpreted as market manipulation.

Define the qualifications of market makers entering into contracts. Registration and approval requirements should be placed at the point where contracts are made with exchanges or issuers. This way, firms manipulating trading volumes under the guise of market makers can be filtered out at the contract stage, while broad liquidity provision with one's own funds remains open as it is now.

Make contracts visible. At a minimum, exchanges and supervisory authorities should know which market makers are involved with what volumes and conditions. Investors should also be aware of which market makers are participating.

Prevent conflicts of interest. If market making occurs within the same group as exchanges, organizations should be separated and subjected to external audits, as in Hong Kong.

Provide obligations and rewards together. By imposing obligations to maintain orders like the Korea Exchange's market maker system and providing appropriate rewards, market makers will have reasons to stay in the market during crises.

Thus, now is the right time to establish these legal and institutional frameworks correctly.

The Digital Asset Basic Law proposed in June 2025 contains provisions excluding market making commissioned by exchanges from market manipulation.

In September 2026, the head of the Financial Services Commission stated in a public forum that the necessity of introducing a market making system would be reviewed.

The Financial Services Commission chairman responded during the National Assembly audit in October 2026 that the bill's contents were already prepared and in the final stages of discussion. The government aims to enact it within the year.

The remaining question is not whether to allow market makers, but under what criteria to allow them. There is a critical point that should not be overlooked here. The currently disclosed bill is centered around a stock market model based on market making commissioned by exchanges. However, many of the issues seen earlier arose not from exchanges but from contracts made with token issuers. If the handling of token issuer contracts is omitted, the largest blind spot outside the system will remain intact.

The opening of the corporate market is also intertwined with this legislation. The Financial Services Commission announced in February 2025 that it would pilot the trading of digital assets for approximately 3,500 listed companies and professional investors. However, guidelines have not yet been finalized, and the timing of the announcement is being reviewed in conjunction with the Digital Asset Basic Law. If the rules for the market where corporate funds will enter do not include market makers within those rules, liquidity provision will remain outside the system even after the market opens.

For the domestic digital asset market to properly accept institutional funds, the perception of market makers must change. Mere regulation will not keep legitimate market makers in the market, nor will it filter out firms that merely borrow the title. The Digital Asset Basic Law represents the first opportunity to shift market makers from being targets of regulation to subjects of management.

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