Bear Market Encryption Trap: The Predatory Tactics of Market Makers and the Insights from TradFi

The encryption industry can definitely learn a thing or two from TradFi.

Written by: Aiying

In the past year, the primary market of the encryption industry has been sluggish, with some even reverting to pre-liberation conditions. Various human behaviors and the regulatory loopholes of “decentralization” have been fully exposed during this “bear market.” Market makers in the industry are supposed to be the “helpers” for new projects, providing liquidity and stabilizing prices to help projects establish a foothold. However, a cooperative model called “loan option model” can be widely appreciated during a bull market, but it is being abused by some unscrupulous actors in the bear market, quietly harming small encryption projects and causing a collapse of trust and market chaos. The traditional financial market has encountered similar problems, but they have relied on mature regulations and transparent mechanisms to minimize harm. I personally believe that the encryption industry can learn something from traditional finance to address these chaos and create a relatively fair ecosystem. This article will delve into the operation of the loan option model, how it digs pits for projects, comparisons with the traditional market, and discussions on the current situation.

1. Loan Option Model: Sounds Good, But There Are Pitfalls

In the crypto market, the task of a market maker is to ensure that the market has enough trading volume by buying and selling tokens frequently, and that the price does not fluctuate because no one is buying or selling. For start-up projects, finding a market maker to work with is almost a must – otherwise it will be difficult to get on the exchange and attract investors. The “loan option model” is a common form of cooperation: the project team lends a large number of tokens to market makers, usually for free or at a low cost; Market makers use these tokens to “make markets” on exchanges to keep the market active. There is often an option clause in the contract that allows market makers to return the tokens at a certain price at a certain point in the future, or simply buy them, but they can choose not to do so.

It sounds like a win-win deal: the project party receives market support, and the market makers earn some trading spreads or service fees. However, the problem lies in the “flexibility” of the option terms and the lack of transparency in the contract. The information asymmetry between the project party and the market makers provides an opportunity for some dishonest market makers to exploit. They take borrowed tokens, not to assist the project, but to disrupt the market and prioritize their own profits.

2. Predatory Behavior: How Projects Get Scammed

If loan option models are abused, they can really harm the project severely. The most common tactic is “smashing the market”: market makers dump borrowed tokens all at once onto the market, causing the price to plummet instantly. Retail investors see something is wrong and start selling off, leading to complete panic in the market. Market makers can profit from this, for example, by “shorting” - selling tokens at a high price first, then buying them back at a low price after the price crashes to return to the project, with the price difference being their profit. Alternatively, they exploit the option terms to “return” tokens at the lowest price, making the cost ridiculously low.

This operation is devastating for small projects. We have also seen many cases where the token price is halved within a few days, and the market value evaporates directly, making it almost impossible for the project to raise funds again. Worse, the lifeline of encryption projects is community trust; once the price crashes, investors either think the project is a “scam” or lose all confidence, leading to the disintegration of the community. Exchanges have requirements for the trading volume and price stability of tokens, and a price plummet may directly result in delisting, leaving the project basically “dead.”

What makes matters worse is that these cooperation agreements are often hidden behind non-disclosure agreements (NDAs), making the details invisible to outsiders. The project teams are mostly newcomers with a technical background, and their awareness of the financial market and contract risks is still very weak. Faced with experienced market makers, they are completely led by the nose and have no idea what “pits” they have signed. This information asymmetry has turned small projects into “fat meat” for predatory behavior.

3. Other pits

In addition, we have encountered many case studies from customer feedback. In the encryption market, market makers not only use the “loan option model” to suppress prices by selling borrowed tokens and abusing option clauses for low-priced settlements, but also have a bunch of other tricks specifically designed to harm inexperienced small projects. For example, they engage in “wash trading,” buying and selling to each other using their own accounts or “shill accounts” to create false trading volume, making the project appear very popular and attracting retail investors. However, once they stop, the trading volume immediately drops to zero, prices crash, and the project may even get kicked out by the exchange.

There are also often “invisible knives” hidden in contracts, such as high margins, outrageous “performance bonuses”, and even allowing market makers to take tokens at a low price and sell them at a high price after listing. There are also market makers who take advantage of information to know in advance that the project is good or bad, engage in insider trading, raise prices to induce retail investors to sell after taking over, or spread rumors to reduce prices and absorb chips. The liquidity “kidnapping” is even more ruthless, they make the project party rely on the service and threaten to increase the price or withdraw the capital, and smash the market if the contract is not renewed, so that the project party cannot move.

Some even promote “bucket” services, like marketing, public relations, and pump strategies. It sounds impressive, but in reality, it’s all fake traffic. After driving up the prices, it crashes, leaving the project parties spending a lot of money and causing trouble. What’s worse, market makers serve multiple projects at the same time, favoring big clients and deliberately lowering the prices of small projects, or transferring funds between projects to create a “rise and fall” dynamic, causing significant losses for small projects. These traps exploit the regulatory loopholes in the encryption market and the inexperience of project parties, leading to evaporated market value and shattered communities.

4. TradFi: There are similar issues, but they are handled better.

The traditional financial market—such as stocks, bonds, and futures—has also encountered similar troubles. For example, a “bear market attack” occurs when a large number of stocks are sold off, driving down prices, and then profits are made from short selling. High-frequency trading firms sometimes use ultra-fast algorithms to gain an edge while making markets, amplifying market volatility to profit themselves. In the over-the-counter (OTC) market, the lack of transparency has also allowed some market makers to engage in unfair quoting. During the 2008 financial crisis, some hedge funds were accused of maliciously short selling bank stocks, exacerbating market panic.

However, speaking of which, the traditional markets have already developed mature methods to address these issues, which are worth learning from the encryption industry. Here are a few key points:

Strict regulation: In the United States, the Securities and Exchange Commission (SEC) has a set of “Rules SHO” that requires short sales to ensure that stocks are actually available to borrow to prevent “naked short selling”. There is also a “rising price rule”, which stipulates that short selling can only be done when the stock price rises, which restricts malicious price reduction. Market manipulation is even more prohibited, and those who violate Article 10b-5 of the Securities and Exchange Act may be fined and even imprisoned. The EU also has a similar Market Abuse Regulation (MAR) that deals specifically with price manipulation.

Information Transparency: Traditional markets require listed companies to report agreements with market makers to regulatory authorities, and trading data (prices, trading volumes) is publicly accessible, allowing retail investors to view it through Bloomberg terminals. Any large trades must be reported to prevent secret “crashing” of the market. This transparency deters market makers from acting recklessly.

Real-time monitoring: The exchange uses algorithms to monitor the market, detecting abnormal fluctuations or trading volumes. For example, if a stock suddenly plunges, it will trigger an investigation. The circuit breaker mechanism is also very practical; when price fluctuations are too large, trading is automatically paused to give the market a breather and prevent panic from spreading.

Industry regulations: Institutions like the Financial Industry Regulatory Authority (FINRA) set 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 not be able to operate.

Protecting investors: If market makers disrupt the market, investors can hold them accountable through class action lawsuits. After 2008, many banks were sued by shareholders for market manipulation. There is also the Securities Investor Protection Corporation (SIPC), which provides certain compensation for losses caused by the misconduct of brokers.

Although these measures are not perfect, they have indeed reduced the predatory behavior in the TradFi market significantly. I believe the core experience of the TradFi market is to combine regulation, transparency, and accountability to create a multi-layered safety net.

5. Why is the encryption market so easily deceived?

I believe that the encryption market is much more vulnerable than the TradFi market, mainly for several reasons:

• Immature regulation: Traditional markets have over a hundred years of regulatory experience and a well-established legal system. What about the encryption market? Global regulation is like a jigsaw puzzle, with many places lacking clear laws against market manipulation or market makers, allowing bad actors to thrive.
• Market too small: The market capitalization and liquidity of cryptocurrencies are far behind that of US stocks. The operations of a single market maker can cause a token’s price to fluctuate dramatically, while it’s not so easy to manipulate large-cap stocks in traditional markets.
• The project party is too “tender”: Many encryption project teams are technical geeks and know nothing about TradFi. They may not even realize the pitfalls of the loan option model and get dizzy from being misled by market makers when signing contracts.
• Opaque practices: The encryption market loves to use confidentiality agreements, with contract details kept tightly under wraps. In the TradFi market, this kind of secrecy has long been under regulatory scrutiny, but in the encryption world, it is the norm.

These factors combined have made small projects the “target” of predatory behavior, and the trust and healthy ecosystem of the entire industry are being gradually eroded by these chaotic phenomena.