Market Making in NFTs

Abstract

This study discusses a framework for market making in Non-Fungible Tokens (NFTs) which represent unique digital assets in a low liquidity and high price volatility environment. The market making problem differs from fungible cryptocurrencies as there is no layered order book structure of market depth and market makers would need to hold inventory on the other side of the trades for a non-negligible horizon. We have developed a model for prices in market making context in terms of embedded optionality of trading an NFT at either the floor or a price that is closer to the appraisal value. In order to develop our model for optionality of trading an NFT, we have used a price model where the price dynamics were decomposed into an intrinsic price diffusion process and jump components relating to liquidity events. Besides NFTs, the approach presented in this paper could provide insights for market making in other "non-fungible" asset classes such as art or housing.

Keywords: NFTs, Digital Assets, Market Making, Market Microstructure