Decentralized market-making

What is Hummingbot

Hummingbot can be considered like a Bitcoin mining node. A mining nodes is a software client that runs either locally or in the cloud. It continually runs the Proof-of-Work algorithm that generates value, but only if you provide it with enough electricity.

Similarly, Hummingbot is a software client that also runs locally or in the cloud. Rather than a hashing algorithm, it runs a market making algorithm. Instead of electricity, it requires users to maintain inventory of tokens in different markets.

What is Market Making

Market making is simply providing continual offers to buy and sell an asset. In traditional markets, market making has been the exclusive province of investment banks, broker dealers, quant hedge funds, high frequency trading shops and other very specialized organizations because only those firms have the right to trade on the exchange directly.

On the other hand, everyone has direct market access in crypto. Both individuals and funds are on a level playing field because they're accessing the same APIs. In addition, the highly competitive nature of crypto exchanges means that exchanges have to be open with their APIs in order to compete with one another. That opens up the possibility for anyone to run essentially a market making bot and profit from earning the bid-ask spread that exists on different exchanges.

In fact, most of our engineering over the past months has really been focused there because even though exchanges have APIs, they're all different, they all have weird edge cases like rate limits, error conditions for you to handle. In addition, we initially built our stack on Python; we realized after a while it was just too slow, so we converted everything to Cython, which is basically Python-like code compiled into low-level C. It made our infrastructure about 1000x faster than where it was previously.

What problem does Hummingbot solve?

Basically, there are both large and small markets, but there are only large market makers currently. These are firms like Jump Trading and DRW Cumberland that focus on making markets in the top trading pairs, like BTC-USD on Coinbase or ETH-USDT on Binance. But once you start going to smaller token pairs and smaller exchanges, that liquidity drops off significantly.

Large market makers have balance sheets in the billions of dollars, so allocating the inventory and technical integration needed to trade small-cap token pairs on decentralized exchanges simply isn't worthwhile when they can focus their efforts on on larger-volume higher-liquidity token pairs. For these smaller markets, individuals and smaller firms are better suited to be market makers.

This problem also exists in traditional markets. US equities markets are facing a "small cap liquidity crisis" in the US because fragmentation of liquidity due to the rise of dark pools and alternative trading systems (ATS) has caused small-cap stocks to suffer from lack of attention by market makers. If you can market make for Apple, why are you bothering with some small penny stocks that are trading on different exchanges? This effect is even more exaggerated in crypto because instead of 13 exchanges, there are hundreds of exchanges around the world, each with dozens to hundreds of token pairs.

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