🆕 How Market-Making, Hedging, and Cross-Exchange Rebalancing Actually Work

Modern crypto exchanges rely on an internal Market-Making (MM) bot to provide liquidity and an external Hedging bot to neutralize exposure. But even with perfect hedging logic, the two bots inevitably fall out of balance unless each side has deep liquidity. This post explains how the system works with a Hedging Bot Control widget to simulate what happens when a user trades with an MM bot behind the scenes.

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What Really Happens When a User Buys BTC?

A user buying BTC on an exchange will in most cases set off a chain reaction of trades across bots and even an outside exchange or even more than one exchange. See user buy action example:

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User buys BTC

• User pays USDT
• User receives BTC

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MM bot reaction (on your exchange)

To fill this order:

• MM bot sells BTC to the user (often with some profit margin, AKA spread)
• MM bot receives USDT
• MM bot becomes BTC-lighter and USDT-heavier

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Hedging bot reaction (on external exchange)

To help neutralize the MM bots exposure to too much USDT:

• Hedging bot buys BTC externally
• Hedging bot spends USDT
• Hedging bot becomes BTC-heavy and USDT-light

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⚠ Important: Hedging bot should buy BTC on an external exchange at a lower price than the MM bot sells to user, which is why MM bots often add an extra price spread.

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When a User Sells BTC: The Exposure Flips

Now the reverse scenario.

Users sells BTC and MM bot gives USDT to the user while simultaneously the hedging bot outside of the exchange will sell BTC to replace USDT given to user from MM Bot.

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⚠ Important: Hedging bot should sell BTC on an external exchange at a higher price than the MM bot bought BTC for from the user.

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Why Perfect Balance Is Impossible Without Large Liquidity

Even if every trade is hedged perfectly, the system cannot stay in perfect equilibrium unless both the MM bot and the hedging bot hold large, deep liquidity pools of both BTC and USDT.

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Why? Because user behavior is unpredictable.

Users might:

• Buy far more BTC than expected
• Sell excessive BTC all at once
• Flip between buying and selling rapidly

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If liquidity is small, the MM bot or hedging bot will quickly run out of one asset.

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This leads to natural drift:

• MM bot may run out of BTC (can’t sell) or run out of USDT (can’t buy)
• Hedging bot may run out of USDT (can’t hedge user buys) or run out of BTC (can’t hedge user sells)

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With deeper liquidity, this is less of an issue. But with limited funds, rebalancing becomes absolutely necessary.

The widget below reflects how exposure can grow, accounts skew, and eventually a suggestion for bot operator to make a transfer to and from each bots account to rebalance. Try it out below:

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⚠ Important: Adding some spread or buffer to the MM bot buy and sell price so that hedging is easier.

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Account Rebalancing (Transfers Between Exchanges)

Eventually the MM bot and the hedging bot outside will drift into dangerous imbalance and could lead orderbooks or OTC broker systems pausing.

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Cross-exchange transfers are required:

• Send BTC from Hedge → MM (so the MM bot can continue selling BTC)
• Send USDT from MM → Hedge (so the hedger can continue buying BTC)

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Or in the opposite scenario:

• Send BTC from MM → Hedge
• Send USDT from Hedge → MM

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These are withdrawals and deposits to and from the different exchanges that the bots live on, not trades.

Note: bots can use the API of the exchange to withdraw and rebalance automatically but generally it is advised to manually rebalance by humen operator.

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Operating an MM bot on your own exchange business

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