The Hidden Traps of the Crypto Market: Potential Risks of Loan Options Model

Recently, the primary market performance of the crypto industry has been sluggish, even showing signs of regression. In this "bear market", some human weaknesses and regulatory loopholes have been fully exposed. As important supporters of new projects, market makers should ideally help projects develop by providing liquidity and stabilizing prices. However, a cooperative model known as the "loan options model", although common and mutually beneficial in a bull market, has been abused by some malicious actors in a bear market, causing serious damage to small crypto projects, leading to a collapse of trust and market chaos.

Traditional financial markets have faced similar problems, but through sound regulation and transparency mechanisms, they have minimized negative impacts. The author believes that the crypto industry can learn from the experiences of traditional finance to address the current chaos and build a fairer ecosystem. This article will delve into the operational mechanisms of the loan options model, its potential harm to projects, comparisons with traditional markets, and an analysis of the current situation.

Options Pricing Model: Appearing Glossy, Concealing Risks

In the crypto market, the main duty of market makers is to ensure sufficient liquidity in the market by frequently trading tokens, preventing prices from experiencing severe fluctuations due to the absence of buyers and sellers. For projects that are just starting out, collaborating with market makers is almost a necessary path, as it is key to getting listed on exchanges and attracting investors. The "loan options model" is a common cooperation model: the project side lends a large number of tokens to the market maker, usually for free or at a low cost; the market maker uses these tokens to conduct "market making" operations on the exchange, maintaining market activity. The contract often includes option clauses that allow the market maker to return the tokens at an agreed price or purchase them directly at a future point in time, but they can also choose not to exercise this option.

On the surface, this seems to be a win-win arrangement: the project team gains market support, and the market makers earn trading spreads or service fees. However, the problem lies in the flexibility of the Options terms and the lack of transparency in the contracts. There is information asymmetry between the project team and the market makers, providing opportunities for some dishonest market makers. These market makers may use borrowed tokens, not to help the project, but to disrupt the market, prioritizing their own interests.

Predatory Behavior: How Projects are Harmed

When the loan options model is abused, it can cause serious damage to the project. The most common tactic is "market smashing": market makers suddenly sell large amounts of borrowed tokens into the market, causing prices to plummet. Retail investors, seeing this anomaly, also sell off in a panic, triggering market fear. Market makers can profit from this, for example, by engaging in "short selling"—selling tokens at a high price first, and then buying them back at a low price after the price collapses to return to the project party, making a profit from the price difference. Alternatively, they may take advantage of the options terms to "return" the tokens at the lowest price, completing the transaction at a very low cost.

This type of operation is devastating for small projects. We have seen many cases where token prices plummeted significantly within just a few days, and the project's market value evaporated rapidly, with opportunities for refinancing basically lost. Worse still, the lifeline of crypto projects lies in community trust; once the price collapses, investors either think the project is a "scam" or completely lose confidence, leading to the disintegration of the community. Exchanges have strict requirements for the trading volume and price stability of tokens, and a sharp price drop may directly lead to the token being delisted, putting the project's prospects in jeopardy.

What is even more concerning is that these cooperation agreements are often covered by non-disclosure agreements (NDAs), making it difficult for outsiders to understand the specific details. The project teams are mostly newcomers with technical backgrounds and have a shallow understanding of financial markets and contract risks. When facing experienced market makers, they often find themselves at a disadvantage and may not even be aware of the "trap" clauses they have signed. This information asymmetry makes small projects vulnerable to predatory behavior.

Other Potential Risks

In addition to the risks of lowering prices by selling borrowed tokens and abusing options terms for low-priced settlement in the "loan options model" mentioned above, crypto market makers have other means that may harm the interests of small projects:

1. False trading volume: By conducting mutual transactions through their own accounts or related accounts, they create false trading activity to attract retail investors. Once this operation stops, the real trading volume may plummet, leading to a price collapse and putting the project at risk of being delisted by the exchange.

2. Contract traps: Setting high margins, unreasonable "performance bonuses" in contracts, or allowing market makers to acquire tokens at low prices to sell them at high prices after listing, causing a price crash and harming retail investors' interests, while the project party bears a bad reputation.

3. Information Asymmetry Arbitrage: Taking advantage of an advantageous position with internal information about a project to engage in insider trading. For example, raising prices to induce retail investors to buy before good news is announced, or spreading rumors to lower prices before bad news in order to accumulate shares at a lower price.

4. Liquidity manipulation: After making the project party overly dependent on its services, threatening to raise prices or withdraw funds. If the project party does not agree to renew the contract, it may face the risk of a sharp price drop.

5. Bundled Sales: Promoting a "package" of services that includes marketing, public relations, and price manipulation may actually mislead project parties and investors by creating false traffic and short-term price increases, ultimately leading to a price collapse and causing economic losses and reputation crises for the project parties.

6. Conflict of interest: When serving multiple projects simultaneously, there may be favoritism towards large clients, intentionally lowering the prices of small projects, or transferring funds between different projects, resulting in some projects benefiting while others suffer.

These practices exploit the weaknesses in regulation of the crypto market and the inexperience of project teams, which may lead to a significant decrease in project market value and a loss of community confidence.

The Response of Traditional Financial Markets

Traditional financial markets------such as stocks, bonds, futures, etc.------have also faced similar challenges. For example, "bear market attacks" lower stock prices through large-scale sell-offs to profit from short selling. High-frequency trading firms sometimes use ultra-fast algorithms to gain an edge while making markets, amplifying market volatility for profit. In the over-the-counter (OTC) market, lack of transparency also provides some market makers with opportunities to manipulate prices. During the 2008 financial crisis, some hedge funds were accused of maliciously shorting bank stocks, exacerbating market panic.

However, traditional markets have developed a relatively mature coping mechanism, and these experiences are worth learning from for the encryption industry. Here are a few key points:

1. Strict regulation: The U.S. Securities and Exchange Commission (SEC) has established Rule SHO, which requires that stocks must be ensured to be borrowed before engaging in short selling to prevent "naked short selling." The "up-tick rule" restricts short selling when stock prices are falling, curbing malicious price manipulation. Market manipulation is explicitly prohibited, and violations of Section 10b-5 of the Securities Exchange Act may face hefty fines or even criminal penalties. The European Union also has a similar Market Abuse Regulation (MAR), specifically targeting price manipulation.

2. Information Transparency: Traditional markets require listed companies to report the content of agreements with market makers to regulatory agencies, and trading data (including prices and transaction volumes) is disclosed to the public. Ordinary investors can view this information through professional terminals. Large transactions must be reported to prevent covert "dumping". This transparency significantly reduces the room for misconduct by market makers.

3. Real-time monitoring: The exchange uses algorithms to monitor the market in real-time. Once it detects abnormal fluctuations or trading volumes, such as a sudden drop in a particular stock, it will trigger an investigation process. The circuit breaker mechanism automatically suspends trading during severe price fluctuations, providing the market with a cooling-off period to prevent the spread of panic.

4. Industry Standards: Institutions such as the Financial Industry Regulatory Authority (FINRA) have established ethical standards for market makers, requiring them to provide fair quotes and maintain market stability. Designated Market Makers (DMM) on the New York Stock Exchange must meet strict capital and conduct requirements, or they will lose their eligibility.

5. Investor Protection: If the actions of market makers disrupt market order, investors can seek compensation through class action lawsuits. After the 2008 financial crisis, several banks were sued by shareholders for market manipulation. The Securities Investor Protection Corporation (SIPC) provides a certain level of compensation for losses caused by the improper actions of brokers.

Although these measures cannot completely eliminate the problem, they have indeed greatly reduced predatory behavior in the traditional market. The core experience of the traditional market lies in the organic combination of regulation, transparency, and accountability mechanisms, creating a multi-layered protection network.

Analysis of Vulnerabilities in the Crypto Market

Compared to traditional markets, the crypto market appears to be more fragile, with main reasons including:

1. Immature regulation: Traditional markets have over a hundred years of regulatory experience and a完善的法律体系. The global regulatory situation in the crypto market is uneven, with many regions lacking clear regulations against market manipulation or market maker behaviors, providing opportunities for bad actors.

2. Smaller market size: The market capitalization and liquidity of cryptocurrencies still have a significant gap compared to mature stock markets. The operations of a single market maker can have a huge impact on the price of a specific token, while large-cap stocks in traditional markets are not easily manipulated.

3. Lack of experience from the project team: Many crypto project teams are primarily composed of technical experts and lack an in-depth understanding of the financial market operations. They may not fully recognize the potential risks of the loan options model and can be easily misled by experienced market makers when signing contracts.

4. Opaque industry practices: The crypto market commonly uses confidentiality agreements, and contract details are often not made public. This practice has long been strictly regulated in traditional markets, but it has become the norm in the crypto world.

These factors combined make small projects more vulnerable to predatory behavior, while also gradually eroding the trust foundation and healthy ecology of the entire industry.