Estimating Market-Making Strategy Capacity from Order Freezing

Summary

The document gives a rough method for estimating the capital capacity of a cryptocurrency market-making strategy. Capacity is defined as the point where adding funds reduces returns or where capital utilization can no longer stay fully effective. In a simplified quoting model, orders have a chance of filling or remaining frozen; once available funds are tied up in unfilled orders, trading stops. The author proposes comparing the typical time the market avoids a large move with the time a given capital amount takes to become fully frozen, then scaling that amount by the ratio of those times.

An illustrative calculation uses an assumed four-hour calm period and a ten-minute freeze time for a specified amount, producing a rough capacity estimate. The author stresses that the method is highly approximate and sensitive to order size and other strategy settings. It also depends on simplified price-movement and fill assumptions. Backtests may misestimate capacity if they omit hidden orders or treat price movement as sufficient evidence of execution without accounting for volume.

Key ideas

• Strategy capacity can be identified by falling returns as capital grows or by an inability to maintain full capital utilization.
• The example estimates capacity by scaling capital according to the ratio of calm-market duration to order-freezing time.
• The calculation depends on assumptions about price movements, order fills, and the strategy's parameters.
• Changing order size can substantially alter the estimated time to freeze available capital.
• Backtests that omit hidden orders or trading volume may misstate capacity.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.