Internal Market Making

Internal Market Making focuses on earning LP fees and spread in IRS pools while keeping interest rate risk (DV01) close to neutral.

Core Idea

You provide liquidity on both sides of the IRS curve while:

• monitoring portfolio DV01

• skewing quotes when exposure grows

• adjusting placement based on statistical edge and fee tiers

This allows you to monetize:

• bid/ask spreads

• taker fees

• temporary imbalances in fixed vs floating demand

Key Building Blocks

DV01 Neutrality

• DV01 measures how much your PnL changes for a 1 bp move in rates

• A neutral market maker keeps net DV01 ≈ 0 across all pools and tenors

If DV01 drifts:

• skew liquidity toward the side that reduces exposure

• widen quotes on the risky side

• or hedge via taking liquidity in another pool

Quote Skewing by Risk

Liquidity is not symmetric:

• If you are long fixed DV01:

  • make fixed cheaper

  • float more expensive

• If you are short DV01:

  • do the opposite

Skew is applied dynamically based on:

• position DV01

• pool liquidity

• recent flow intensity

Statistical Spread Forecasting

Rather than static spreads, quotes adapt using:

• historical spread distributions

• volatility regimes

• utilization and flow imbalance

• time-to-maturity decay

This helps:

• tighten spreads when risk is low

• widen spreads during stress

• prioritize pools with better risk-adjusted returns

Fee Tier Positioning

Pools support multiple fee tiers.

Market makers can:

• place tighter liquidity in low-fee tiers for high-volume flow

• place wider liquidity in higher-fee tiers for toxic or volatile flow

Fee tier selection is part of the edge.

Smart AMM Features

XCCY vAMM supports:

• asymmetric liquidity placement

• curve-based depth adjustment

• DV01-aware inventory constraints

• multi-pool netting via portfolio margin

These allow capital to be reused efficiently while managing exposure.

Execution Flow

1. Choose correlated pools (same asset or cluster)

2. Enable portfolio margin or X-Mode

3. Provide liquidity on both fixed and floating sides

4. Monitor:

   • net DV01

   • utilization

   • fee capture

5. Rebalance or hedge as needed

Risk Notes

• DV01 neutrality reduces but does not eliminate risk

• Fast rate moves can temporarily dislocate pools

• Liquidity can be consumed unevenly across tenors

Proper monitoring and automation are recommended.

When This Strategy Works Best

• high trading volume environments

• active hedging demand

• stable or mean-reverting rate regimes

Avoid during:

• one-sided panic flows

• sudden regime shifts without sufficient depth

Variations

• pair with Hedged Market Making

• add cross-tenor hedges

• combine with funding arbitrage strategies

Next strategies build on this foundation.