Hidden Traps in the Crypto Market: Potential Risks of Loan Options Models

In the past year, the primary market of the encryption industry has experienced a severe contraction, with many projects facing difficulties. In this "bear market" environment, various issues and regulatory loopholes within the industry have been laid bare. Market makers are supposed to be a boost for new projects, helping them to establish a foothold by providing liquidity and stabilizing prices. However, a cooperative method known as the "loan options model," while potentially beneficial for all parties in a bull market, has been abused by some dishonest participants in a bear market, causing serious harm to small encryption projects, leading to a collapse of trust and market chaos.

Traditional financial markets have faced similar challenges, but through improved regulation and transparent mechanisms, have minimized such damages. The crypto industry can draw lessons from traditional finance to address the current chaos and establish a fairer ecosystem. This article will delve into the operational mechanisms of the loan options model, its potential harms to projects, comparisons with traditional markets, and the current state of the market.

Options Loan Model: Appearing Glossy, Concealing Risks

In the crypto market, the main responsibility of market makers is to ensure sufficient trading volume by frequently buying and selling tokens, preventing drastic price fluctuations caused by the absence of buyers and sellers. For emerging projects, collaborating with market makers is almost a necessary step, as it not only helps in listing on exchanges but also attracts investors. The "Loan Options Model" is a common form of collaboration: the project parties borrow a large number of tokens from market makers at low cost or for free; market makers use these tokens to perform market-making operations on exchanges, maintaining market activity. The contract usually includes an options clause, allowing market makers 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 model seems to achieve a win-win situation: the project party gains market support, while the market makers earn trading spreads or service fees. However, the problem lies in the flexibility of the options terms and the opacity of the contracts. The information asymmetry between the project party and the market makers provides opportunities for some dishonest market makers. They may take advantage of borrowed tokens to disrupt the market, placing their own interests above those of the project.

Predatory Behavior: How Projects Get into Trouble

When the loan Options model is abused, it can severely impact the project. The most common tactic is "smash the market": market makers concentrate and sell off a large number of borrowed tokens, causing prices to plummet sharply, triggering panic selling among retail investors, and ultimately leading the market into chaos. Market makers can profit from this, for example, by using "short selling"—selling tokens at a high price first and then buying them back at a low price after the price crashes to return to the project party, making a profit on the difference. Alternatively, they may take advantage of the Options terms to "return" tokens at the lowest price, thereby achieving profits at an extremely low cost.

This kind of operation can have a devastating impact on small projects. We have seen many cases where token prices plummeted significantly within just a few days, causing the project's market value to evaporate, making subsequent financing nearly impossible. Worse still, the lifeline of crypto projects lies in community trust; once the price collapses, investors either believe the project is a scam or completely lose faith, leading to the disintegration of the community. Exchanges have strict requirements for trading volume and price stability of tokens, and a price crash can directly lead to the token being delisted, resulting in project failure.

What makes matters worse is that these cooperation agreements are often concealed by non-disclosure agreements (NDAs), making it difficult for outsiders to understand the specific details. Most project teams are composed of newcomers with technical backgrounds, who have a limited understanding of the financial markets and contractual risks. When faced with experienced market makers, they often find themselves at a disadvantage and may unwittingly sign agreements that are unfavorable to them. This information asymmetry makes small projects easy victims of predatory practices.

Other Potential Risks

In addition to issues such as driving down prices by short-selling borrowed tokens and abusing option terms for low-price settlements in the loan options model, market makers in the crypto market also exhibit other undesirable behaviors, especially targeting inexperienced small projects:

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

2. Concealed contract terms: The contract may include high margins, unreasonable "performance bonuses", or allow market makers to acquire tokens at low prices and sell them at high prices after listing, resulting in a price crash that harms retail investors and poses reputational risks for the project parties.

3. Insider trading: Using informational advantages to trade before major project announcements or spreading false information to influence price trends for profit.

4. Liquidity manipulation: Threatening to raise prices or withdraw funds after the project party becomes overly reliant on its services, forcing the project party to accept unfavorable terms.

5. Bundled Sales: Promoting a "full set of services" that includes marketing, public relations, price support, etc., may actually create an illusion through artificial means, and once stopped, the project may face serious consequences.

6. Differential Treatment: When serving multiple projects simultaneously, the interests of large clients may be prioritized, intentionally lowering the prices for small projects, or transferring funds between different projects, resulting in certain projects being harmed.

These actions exploit the gaps in the regulation of the crypto market and the weaknesses of inexperienced project teams, which may lead to a significant decrease in project market value and the disintegration of the community.

The Response of Traditional Financial Markets

Traditional financial markets - such as stocks, bonds, futures, and other areas - have also faced similar challenges. For example, "bear market attacks" profit from short selling by massively offloading stocks to depress prices. High-frequency trading firms may leverage algorithmic advantages to gain an edge when making markets, amplifying market volatility. The lack of transparency in the over-the-counter (OTC) market also provides some market makers with opportunities for unfair pricing. During the 2008 financial crisis, some hedge funds were accused of exacerbating market panic by maliciously shorting bank stocks.

However, traditional markets have developed a mature set of coping mechanisms that the encryption industry can learn from:

1. Strict Regulation: The U.S. Securities and Exchange Commission (SEC) has established Rule SHO, which requires that stocks must be borrowed before short selling to prevent "naked short selling". The "up-tick rule" restricts short selling when stock prices are falling. Market manipulation is explicitly prohibited, and violations of relevant regulations may face severe penalties. The European Union also has a similar Market Abuse Regulation (MAR) to prevent price manipulation.

2. Information Transparency: Traditional markets require listed companies to report agreements with market makers to regulatory authorities, and trading data (such as prices and trading volumes) is publicly accessible. Large transactions must be reported to prevent covert "dumping". This transparency effectively curbs inappropriate behaviors by market makers.

3. Real-time monitoring: The exchange uses algorithms to monitor the market, detecting abnormal fluctuations or trading volumes. The circuit breaker mechanism automatically suspends trading during severe price fluctuations, cooling down the market and preventing panic from spreading.

4. Industry Standards: For example, the Financial Industry Regulatory Authority (FINRA) has 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.

5. Investor protection: If market makers disrupt the market, investors can seek compensation through class action lawsuits. The Securities Investor Protection Corporation (SIPC) provides certain protection for losses caused by broker misconduct.

These measures, while not perfect, have effectively reduced predatory behavior in traditional markets. The core experience of traditional markets lies in combining regulation, transparency, and accountability to build a multi-layered protection mechanism.

The Vulnerability Roots of the Crypto Market

Compared to traditional markets, the crypto market appears to be more vulnerable, primarily due to:

1. Immature regulation: Traditional markets have hundreds of years of regulatory experience and a well-established legal system. In contrast, the global regulation of the crypto market is still fragmented, with many regions lacking clear regulations against market manipulation or market maker behavior, leaving opportunities for bad actors.

2. Small market size: The market capitalization and liquidity of cryptocurrencies are far lower than those of traditional stock markets. The actions of a single market maker can have a huge impact on the price of a particular token, whereas large-cap stocks in traditional markets are not easily manipulated.

3. Lack of experience from the project parties: Many crypto project teams are primarily composed of technical experts, with limited understanding of the financial market. They may not fully recognize the potential risks of the loan options model and can be easily misled by market makers when signing contracts.

4. Opaque culture: The crypto market commonly uses confidentiality agreements, and contract details are often not disclosed to the public. This practice, which has long been a focus of regulatory scrutiny in traditional markets, has become the norm in the crypto world.

These factors combined make small projects easy targets for predatory behavior, while also threatening the trust foundation and healthy development of the entire industry.