[Level 2] Use Cross-Exchange Market Making (XEMM) Strategy to Lower Risk
What is cross exchange market making?
Cross exchange is a maker-taker strategy. Read more through the docs link and blog below :
The cross exchange market making strategy performs market making trades between two markets: it emits limit orders to a less liquid, larger spread market; and emits market orders on a more liquid, smaller spread market whenever the limit orders were hit.
Arbitrage and cross-exchange market making are often considered and described as "risk-free" because these strategies largely mitigate the main risk associated with market making: inventory risk. This makes this strategy more beginner friendly. The main risk that remains is execution risk.
This article explains :
- the basic concepts cross-exchange market making
- the difference between cross-exchange market making and arbitrage and pure market making strategies
- why and when we can use this strategy
Cross exchange market making reduces inventory risk
Arbitrage and cross-exchange market making are often considered and described as "risk-free" because these strategies largely mitigate the main risk associated with market making: inventory risk. The main risk that remains is execution risk. To learn more, please read the following blog post:
The concept behind cross exchange market making strategy
Our video is outdated in terms of Hummingbot UI but explains the idea of cross exchange market making strategy.
Basically, you want to make a market on a less liquid exchange or pair and take from the more liquid market. Your order prices are based on how much you can buy or sell the asset from the other market.
Let's say you live in a remote area with a fair amount of population but only a couple of stores open to buy goods or merchandise from, therefore we can say that the market in your area is illiquid.
A liquid market is like a commercial area of the city where there are lots of shopping malls and stores that offers to buy and sell even if they have the same kind of goods and services.
Since there's a lot of competition in the city, stores would most of the time compete with each other's prices to attract customers. But in your area, prices can be a lot higher because you have to consider other expenses in obtaining those goods like taxes (similar to fees) and sometimes transportation costs or you'll be able to sell your used items at a very low price than you wanted because they have to consider their costs and how much they can profit if they sell it in the more liquid market.
As an example, let's say you decided to put up a store in your remote area where you buy & sell any sort of goods and call it STORE A. In doing this, you add liquidity to the market. Let's call the stores in the city STORE B. You also need to have a starting inventory - some cash available to buy stuff from others and some merchandise you want to sell.
Creating sell order in maker, executing a buy order from taker market
You're thinking of selling an item and want to make a 20% profit from it. So you checked the price at STORE B and saw that you can buy the exact same item for $100 (tax not yet included).
Initially, you were thinking of selling it at $120 but you also have to consider taxes (fees) in making those trades. Taxes are at 0.1% and since you're making two trades (sell and buy), you have to pay for it twice. So you want to sell it for $120.22 because :
$120 + $0.12 tax ( 0.1% for selling at $120 ) + $0.1 tax ( 0.1% for buying at $100 )
You've put it in display waiting for someone to drop by your store and buy the item. When the item was sold you went to STORE B, bought the exact same item for $100.1 including tax and profited $20 from those trades.
Creating buy order in maker, executing a sell order from taker market
It works the same as the example above, but in reverse. In this case, you want to buy items at the price of how much you can profit from selling it at the more liquid market.
Setting price source configurations
The inefficiencies caused by the highly fragmented cryptocurrency market create a lot of opportunities for arbitrageurs and market makers, who can take advantage of the price discrepancies between all the markets. One helpful way is to make use of our price source configurations to navigate these price discrepancies.
In this blog, you will learn:
- The configurations you can use on Hummingbot to set price sources
- The various price sources Hummingbot can use as a reference
- How the information about price moves around different markets
- Why we should use the price information from a different source
Cross-exchange market making in action
Understand how you can apply cross-exchange market making in action.