Law and Ledger is a news segment focusing on crypto legal news, brought to you by Kelman Law, a law firm focused on digital asset commerce. The editorial below was written by Michael Handelsman for Kelman.Law, addressing critical risk management strategies for digital asset projects entering into agreements with liquidity providers.
When a token project prepares for an initial exchange listing, founders face immense pressure to secure robust market support. In a typical scenario, a market maker offers to bolster liquidity in exchange for a token loan and an option to purchase a portion of the token allocation. The proposal is invariably framed around desirable outcomes: tighter spreads, deeper order books, and a smooth, stable launch. For many early-stage projects, securing these commitments feels essential to surviving the volatile opening days of public trading.
However, several months down the line, projects often attempt to recall their loaned tokens, only to encounter unexpected friction. Market makers may point to option exercise provisions, extended repayment schedules, or broad contractual authority to hold inventory across third-party exchanges. In these moments, founders frequently discover a harsh reality: their colloquial understanding of "providing liquidity" was never properly translated into enforceable legal terms within the written agreement.
Legal experts emphasize that before transferring any treasury inventory, a project must understand precisely what the market maker is permitted to do with the tokens, how performance will be measured, and what must be returned at the conclusion of the arrangement. These foundational provisions deserve just as much commercial and legal attention as headline fees or service discounts.
Define the Token Loan and Purchase Rights
Safeguarding a project’s treasury begins with clearly identifying the legal entities involved in the transaction. This means explicitly establishing the entities providing the tokens, performing the services, and owing repayment. If a decentralized foundation holds the project’s treasury assets while a separate development company executes the operational agreement, founders must establish the foundation’s formal authorization and contractual rights to ensure accountability.
Agreements must also carefully distinguish among a straightforward loan, an outright sale of assets, and digital inventory held for trading on the project’s behalf. Contractual documents should state explicitly whether ownership of the tokens transfers upon delivery, whether the recipient is permitted to commingle the inventory with other assets, and whether the recipient is obligated to return equivalent tokens or account for specifically held assets.
Where the market maker receives a purchase option as part of its compensation, negotiations must address the precise quantity, exercise price, expiration terms, notice procedures, settlement currency, and how the option interacts with underlying repayment obligations. Consider a hypothetical arrangement involving the loan of one million tokens accompanied by an option to purchase them at fifty cents each. If the token’s market value subsequently rises to two dollars, an exercise of the option could allow the market maker to pay five hundred thousand dollars instead of returning tokens with a quoted market value of two million dollars. While this may represent an intentional commercial bargain agreed upon by both parties, the project must thoroughly model these financial scenarios before signing the contract.
Furthermore, agreements must address partial option exercises, token migrations, total supply changes, and early termination events. Founders should determine whether a purchase option survives a service breach by the market maker and whether repayment obligations are reduced only after a valid exercise and corresponding payment are completed.
Translate the Proposal into a Measurable Trading Mandate
Broad promises to "maintain liquidity" leave substantial room for disagreement and operational ambiguity. To prevent misunderstandings, agreements should specify the approved exchanges, designated trading pairs, inventory allocations, and specific services expected on each individual venue.
Useful performance metrics can include maximum quoted spreads, minimum order-book depth within defined price bands, and the percentage of time that qualifying quotes remain active and available to the public. To ensure these metrics are enforceable, the contract must define the reference price, measurement intervals, approved data sources, and the contractual treatment of unexpected exchange outages.
These commitments should be negotiated as enforceable service obligations accompanied by realistic exceptions. Projects must avoid contractual language that treats a desired token price or artificial transaction volume as the actual service being purchased, as such terms invite regulatory scrutiny and operational instability. Trading authority also requires strict boundaries. Contracts should address whether the market maker is permitted to transfer inventory between trading venues, lend tokens onward, pledge them as collateral, use financial leverage, or hedge positions through derivatives. If hedging activities are permitted, the agreement must identify their precise purpose, operational limits, and reporting requirements. For accounts controlled directly by the project, founders should consider whether trading-only permissions provide sufficient operational freedom while ensuring that asset withdrawals require separate, multi-sig authorization.
Require Lawful Activity and Meaningful Oversight
Any promise of volume support warrants rigorous scrutiny of the counterparty’s actual trading strategies. Federal enforcement actions highlight the severe risks associated with poorly monitored market-making relationships. Notably, the United States Department of Justice announced the sentencing of a cryptocurrency financial services founder following a guilty plea to conspiracy to commit market manipulation and wire fraud. That case involved automated trading bots that conducted wash trades to generate misleading market activity. The practical lesson for emerging token projects is clear: founders must examine precisely how promised market results will be achieved.
To mitigate these risks, agreements should explicitly prohibit manipulative trading practices, deceptive orders, and coordinated transactions designed to manufacture false market activity. Contracts must require strict compliance with applicable laws and exchange venue rules, backed by internal controls appropriate to the trading strategy.
Moreover, projects should secure contractual rights to investigate suspicious trading activity, obtain relevant records on demand, and suspend trading operations when necessary. A general, high-level compliance warranty provides little operational protection if the project lacks the visibility required to see what is happening in real time. Prior enforcement actions and SEC crypto litigation releases provide important background on the regulatory allegations facing liquidity providers, transforming abstract compliance concerns into concrete oversight rights during contract negotiations.
Make Reporting Sufficient to Reconcile the Inventory
A basic dashboard showing aggregate trading volume does not explain where a project’s assets are currently located or how they have been utilized over time. Project teams must negotiate comprehensive reporting requirements that allow them to accurately reconcile their inventory positions.
This includes specifying the frequency of reporting, standardized delivery formats, data record retention policies, and continued access to information following contract termination. Agreements should require prompt notification of any withdrawal restrictions, security incidents, material trading errors, or regulatory inquiries that could affect market-making performance.
Contracts must also clearly distinguish operational trading gains and losses from standard service fees. Parties must determine who receives exchange fee rebates, who ultimately funds trading losses, and whether the market maker is permitted to deduct disputed charges from its repayment obligations. A project should always be able to reconstruct its financial position independently, rather than relying entirely on the market maker’s explanation of a proprietary dashboard.
Address Conflicts, Information Use, and Exclusivity
Market makers often maintain complex commercial interests that may conflict with the long-term goals of the token project. Founders should review a provider’s ability to trade for its own proprietary account, service competing token projects, transact with corporate affiliates, and receive compensation from cryptocurrency exchanges or other external counterparties.
Agreements should mandate the disclosure of material conflicts of interest and establish clear protocols for how those conflicts will be managed. Confidentiality provisions must address the handling of nonpublic information concerning upcoming token listings, token unlocks, treasury transactions, and commercial announcements.
Exclusivity clauses also deserve careful attention. A broad, unconditional exclusivity restriction could prevent a project from appointing an alternative liquidity provider even when the incumbent’s performance deteriorates significantly. Projects should consider limiting exclusivity by venue, trading pair, duration, and the ongoing satisfaction of measurable service standards. Furthermore, projects must retain approval rights over any public statements suggesting that a market maker guarantees a token’s ultimate price, exchange listing, or commercial success.
Negotiate the Exit Before Delivering the Tokens
Contract termination and asset repayment are separate legal obligations. Ending a service relationship should trigger a well-defined operational process for halting new trades, closing permitted positions, reconciling account balances, and returning all remaining inventory.
Agreements should specify required notice periods, cure rights for minor defaults, and circumstances that permit immediate suspension or termination. These triggers should encompass material breaches, unauthorized asset use, persistent performance failures, the loss of necessary regulatory permissions, and unforeseen security incidents.
Regarding repayment, contracts must explicitly identify the specific token, blockchain network, destination-verification procedures, return deadlines, and responsibility for transaction fees. If cash substitution is permitted in lieu of token return, the agreement must define who holds the right of election and how valuation will be calculated.
Furthermore, agreements must address exchange withdrawal freezes expressly. Parties must decide whether the market maker remains strictly responsible for timely repayment regardless of exchange downtime, and what evidentiary or mitigation steps it must provide if funds are temporarily locked. An open-ended repayment extension tied to a venue reopening can leave a project unable to recover its treasury inventory when it is needed most. Finally, agreements should preserve reporting, audit, confidentiality, and dispute-resolution obligations even after the contract has been terminated.
Review Liability Limits and Recovery Prospects Together
A standard liability cap based solely on a few months of service fees is commercially inadequate when a market maker controls a substantial multi-million-dollar token allocation.
Negotiations should address how liability caps apply to repayment obligations, unauthorized asset transfers, fraud, willful misconduct, and confidentiality breaches. Indemnification clauses must be reviewed alongside exclusions of damages and defense-control provisions to ensure they operate coherently under the chosen governing law.
Founders must also realisticly assess the counterparty’s financial capacity and determine whether collateralization or a corporate guarantee is appropriate. A contractual recall right does not guarantee immediate financial recovery; in a U.S. bankruptcy proceeding, the automatic stay under federal bankruptcy law can severely restrict collection and enforcement efforts, subject to narrow statutory exceptions. Legal counsel should evaluate the specific insolvency treatment of an arrangement before a project relies entirely on contractual remedies.
Ultimately, selecting governing law and a judicial forum with local enforcement in mind is critical. Identifying where the counterparty and its underlying assets are physically located ensures that projects retain access to urgent legal relief if disputes arise.
Kelman PLLC’s commercial transactions practice assists digital asset businesses with negotiating and documenting these complex agreements. Before committing treasury inventory to a liquidity provider, projects are advised to consult legal counsel to review proposed terms, token allocations, trading mandates, and repayment structures.
Attorney Advertising. This article provides general information, not legal advice. Rights and obligations depend on the specific agreement, applicable law, and underlying facts. Contacting the firm does not establish an attorney-client relationship.
Bitcoin & Major Altcoins
Bitcoin & Major Altcoins
Bitcoin & Major Altcoins
