Imagine you are a crypto project getting ready to go big. You have been through all the hard work of developing your product, building up your community, and preparing to hit the market. The only thing in your way is price volatility. Wild swings in price can bring chaos to the launch of your token within the crypto market. To keep your token attractive to investors, you need liquidity and price stability. This is where crypto market making comes into play and where strike prices truly are a game changer.
The strike prices are very often a part of the loan deals or option agreements between crypto market makers and token projects. They help to provide predictable buy and sell prices, hence giving some sense of control in an otherwise very unpredictable market.
At Yellow Capital, we know how critical strike prices can be for stability and, more importantly, for the long-term success of a token. Let’s break down what strike prices are, how they work in crypto market making, and why they can be a strong tool but also carry risk.
What is a Strike Price in Crypto?
In the context of a loan contract, the strike price refers to the agreed price at which a token can be bought or sold. It is similar to setting a fixed deal price for the future, irrespective of what happens in the open market.
Think of this as a reservation in your favorite restaurant. No matter how busy it gets, you have your table reserved. In crypto trading, the strike price is a way for market makers and token projects to “reserve” a price to hedge against unpredictable market swings.
For example, if a market maker is willing and agrees to buy tokens issued by a project at $2, even when the price goes up to $3 in the market, they still get to have the tokens at $2. On the other side, if it falls to $1 in the market, the project nonetheless benefits from the $2 strike. This creates a layer of predictability in the normally volatile crypto market.
How Strike Prices Work in Crypto Market Making Deals
Loan Deals and Strike Prices
In a loan deal, a crypto market maker borrows tokens from a project to provide liquidity on exchanges. The project and the market maker determine a strike price, which equals the later payout price for those tokens. This can be especially useful during a new token launch when liquidity is needed, but the price is still finding its footing.
Suppose a new project, “CryptoTokenX,” signs a loan deal with a market maker, and they agree that the price will be the daily average price for the first two weeks of the contract. A market maker borrows tokens and ensures smooth trading and liquidity in the market, taking most of the price-related financial risks. If the price surges to $2 or more, this market maker still has the right to buy tokens from the project at $1.50. This arrangement helps maintain stability and predictability in the market for both sides.
Option Deals and Strike Prices
In an option deal, the strike price is a price at which the market maker may-but is not obligated to-buy or sell tokens within the predetermined period. A call option allows buying at the price, while a put option allows selling.
This can be explained further to the point by considering, for instance, if a crypto market maker buys a call for a token at $5 and market reaches $7-then it is still possible with this to buy it for U$5 and fix the profit. Contrariwise, if the price goes to U$4, MM can choose not to exercise the option, avoiding a loss.
Why Strike Prices Matter for Token Projects
Managing Volatility
The strike price gives the token projects some price stability, especially during key events like launches or majorexchange listings. In a crypto market where prices can surge or nosedive within hours, it is the strike price that locks in a surety of the price.
Imagine making an important announcement and watching a token go on the price rollercoaster within minutes. Onboarded market makers in this situation will help to deal with the impact that the announcement might cause by properly managing liquidity.
Ensuring Liquidity
Liquidity is the backbone of successful crypto trading. Without it, your token can become difficult to trade, frustrating investors and damaging your reputation. Strike prices help market makers commit to providing liquidity, knowing they have a predictable buy or sell price in place. But they sometimes might not favor projects.
But Yellow Capital’s loan models go beyond market standards, ensuring liquidity deals that add real, lasting value for clients. This approach helps projects avoid the dreaded “liquidity crunch” that can doom new tokens.
Pros of Using Strike Prices in Crypto Deals
- Predictable Costs and Revenues: Token projects and market makers can plan around fixed prices, helping with budgeting and forecasting.
- Hedging against volatility: The strike price protects against sudden price swings, thus making the trading conditions quite stable.
- Flexible Trading Strategies: Market makers can follow various strategies, such as arbitrage, without getting surprised by price changes.
- Liquidity support: The strike price can be an incentive to attract market makers to apply continuous liquidity, ultimately yielding a better trading experience for others.
Cons of Using Strike Prices in Crypto Deals
- Missed Profit Opportunities: When the market price goes above the strike price, and the token projects end up selling at a lower price than they could have.
- Market Manipulation Risk: Early price determination can be vulnerable to bad actors trying to manipulate the market.
- Complex Agreements: Poorly structured deals can lead to unfavorable terms.
- Liquidity Crunch: In case of an adverse movement in the market, the market makers become hesitant to fulfill their commitments.
How to Set an Effective Strike Price
Market Analysis is Key
Setting a strike price without understanding the market is similar to driving with both eyes shut. Both projects and token market makers have to consider the history of the price, the feeling in the market, and what might happen in the future.
Typically, the strike price in a crypto market making contract is determined in the first two weeks of collaboration, whereby the project and market maker could get the feeling of the market conditions, trading volume, and price action in the beginning before settling upon the strike price.
Assuming “CryptoTokenX” is launching the token, and it is traded in the range between $1.20 and $1.80 in the first two weeks. In this case a strike price will be at $1.50. However, if the token shows signs of significant upcoming demand—perhaps due to an anticipated announcement or partnership—you may want to adjust accordingly.
Work with Experienced Market Makers
A partnership with an established crypto market maker like Yellow Capital would make a big difference. For instance, we apply advanced analytics and rich crypto market making experience to assist projects in estimating such strike prices that fit not only near-term but even longer-term needs.
Imagine a new DeFi token about to go live. Instead, the project team will consult with Yellow Capital to avoid striking some random price. Yellow Capital analyzes market conditions, volume traded, and competitor data in the first two weeks of window recommendations of strike price so that it is always representative of real market behavior.
Consider Flexibility in Contracts
The crypto market is as volatile as it gets. Just having a rigid strike price with no accounting for market changes can backfire. Being flexible in your strike prices, with price triggers can add some balance of protection.
You can, for instance, agree on the strike price at $2 with a caveat that when it overshoots $3, after some time, there should be a review of the price. In that way, you are covering both your backs, and it will be a fair deal for both.
Risks of Early Strike Price Determination
Market Volatility
Setting the strike price in the first two weeks of a partnership gives an indication of early market behavior, but this period can be alarmingly volatile. A new token launch often undergoes wild swings in prices that are not indicative of its long-term value. This will definitely bring less-than-favorable results for a project when the strike price is set too high or too low within this narrow window.
Missed Profit Potential
If the token’s price spikes significantly after the strike price is set, the project may miss out on potential profits. For example, if the strike price is locked at $1.50 but the market price soon rises to $3, the project is locked into selling at a lower price, leaving money on the table.
Manipulation Risk
If the token’s price spikes significantly after the strike price is set, the project may miss out on potential profits. For example, if the strike price is locked at $1.50 but the market price rises to $3, the project is locked into selling at a lower price, leaving money on the table.
Incomplete Market Data
Two weeks is an extremely short period to understand the full market dynamics. Factors like pending exchange listings, marketing campaigns, or news announcements might not have played out yet, leading to a strike price that doesn’t reflect the token’s actual potential.
Strategies to Mitigate Early Strike Price Risks
Dynamic Strike Price Mechanisms
Consider dynamic pricing models that avoid the pitfalls of early strike price determination. In this case, the strike price will be pegged to predefined conditions or milestones, such as trading volume, exchange listings, or market sentiment.
Staggered Pricing Windows
Consider staggered pricing windows, instead of setting one single strike price early on. For example, determine an initial strike price in the first two weeks, then revisit and adjust it after 30 days. This approach gives both the project and the market maker more flexibility to adapt to market conditions.
Common Mistakes to Avoid When Setting a Strike Price
Ignoring Market Data
Failing to analyze the trading data during the first 2 weeks can lead to a strike price that doesn’t reflect reality.
Rigid Contracts
Inflexible agreements that don’t leave room for adjustments can backfire in volatile markets.
Underestimating Volatility
The crypto market is extremely volatile. Consider different scenarios when setting the strike price.
Working with Inexperienced Market Makers
Choose partners like Yellow Capital, which has a proven track record in crypto market making.
Lack of Flexibility in Pricing Windows
Consider staggered pricing windows or dynamic clauses to adapt to market changes.
Final Thoughts
The strike price is a strong instrument of crypto market making, bringing stability and predictability to a volatile market.
While setting a strike price within the first two weeks of a partnership is a common practice, it has risks.
Accumulating experience from their practice, market makers such as Yellow Capital help the token project avoid common mistakes that would likely make them rigid and confidently feel their way through the unpredictable crypto market.
When done correctly, strike prices provide liquidity, control volatility, and allow for the successful trading of cryptocurrencies.