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

In the past year, the primary market of the cryptocurrency industry has experienced a significant decline. This sluggish market environment has exposed many human weaknesses and regulatory loopholes. As important supporters of emerging projects, market makers should help projects develop by providing liquidity and stabilizing prices. However, a collaborative approach known as the "loan options model" may be beneficial for both parties during a bull market, but it has been abused by some irresponsible participants during a bear market, causing serious harm to small crypto projects, leading to a collapse of trust and market chaos.

Although traditional financial markets have also faced similar problems, they have minimized potential harm through mature regulation and transparency mechanisms. The crypto industry can fully learn from the experiences of traditional finance to address the current chaos and establish a fairer ecosystem. This article will delve into the operational mechanism of the loan Options model, its potential risks to projects, comparisons with traditional markets, and an analysis of the current market situation.

Options Loan Model: Surface Attractive, but Actually Dangerous

In the crypto market, the responsibility of market makers is to ensure sufficient market liquidity by frequently buying and selling tokens, preventing severe price fluctuations caused by the absence of buyers and sellers. For emerging projects, collaborating with market makers is almost a necessary choice; otherwise, it is difficult to land on trading platforms or attract investors. The "loan options model" is a common form of collaboration: the project party lends a large number of tokens to the market maker at a very low or zero cost; the market maker uses these tokens to conduct market-making operations on the trading platform, maintaining market activity. The contract usually includes options clauses, allowing market makers to return tokens or purchase them directly at an agreed price at specific future points in time, but they can also choose not to exercise this option.

On the surface, this model seems beneficial for both parties: the project gains market support, while the market makers earn trading spreads or service fees. However, the problem lies precisely in the flexibility of the options terms and the opacity of the contracts. There is an information asymmetry between the project parties and the market makers, providing opportunities for some dishonest market makers. They may exploit borrowed tokens to disrupt market order, placing their own interests above the project's development.

Predatory Behavior: Specific Damages Suffered by the Project

When the loan options model is abused, it can severely impact the project. The most common tactic is "dumping": market makers concentrate on selling borrowed tokens, causing prices to plummet rapidly, which triggers panic selling by retail investors and leads to market collapse. Market makers can profit in various ways, such as through "short selling" operations---selling tokens at a high price first, then buying them back at a low price after the crash to return to the project party, pocketing the difference. Alternatively, they may leverage options clauses to "return" tokens at the lowest price, resulting in a very low actual cost.

Such operations can have a devastating impact on small projects. We have seen many cases where project token prices were halved in just a few days, leading to a significant evaporation of market value, making subsequent financing almost impossible. Worse still, the lifeline of crypto projects lies in community trust; once the price collapses, investors either perceive the project as a scam or completely lose confidence, resulting in the disintegration of the community. Trading platforms have strict requirements for the trading volume and price stability of tokens, and a price crash can directly lead to token delisting, putting the project in jeopardy.

What makes matters worse is that these cooperation agreements are typically protected by non-disclosure agreements (NDAs), making it difficult for outsiders to understand the specific details. The project teams are often newcomers with a technical background, lacking significant understanding of the financial markets and contract risks. When faced with experienced market makers, they often find themselves in a passive position, struggling to recognize the potential risks associated with what they are signing. This information asymmetry makes small projects easy targets for predatory behavior.

Other Potential Risks

In addition to the issues mentioned in the "Loan Options Model" where borrowed tokens are sold to suppress prices and the abuse of option terms for low-price settlements, market makers in the crypto market also employ other tactics targeting inexperienced small projects. For instance, they might engage in "wash trading," using their own or associated accounts to trade with each other, creating a false trading volume that makes the project appear very active and attracts retail investors. However, once this operation stops, the real trading volume quickly drops to zero, leading to a price collapse and putting the project at risk of being delisted from trading platforms.

Contracts often hide some unfavorable terms, such as high margin requirements, unreasonable "performance bonuses", and even allow market makers to acquire tokens at low prices and sell them at high prices after listing, causing huge selling pressure that leads to a price crash, resulting in losses for retail investors while the project parties bear the blame. Some market makers also take advantage of information asymmetry to gain early access to important project news and engage in insider trading, inducing retail investors to take over and sell after the price is driven up, or spreading rumors to lower prices in order to accumulate tokens at a lower cost.

Moreover, some will "kidnap" the liquidity of projects, threatening to raise prices or withdraw funds once the project parties become dependent on their services. If the contract is not renewed, they threaten to crash the market, putting the project parties in a dilemma. Some market makers also promote a "full set of services" including marketing, public relations, and pump-and-dump schemes, but in reality, these services may only create false traffic. After the price is artificially inflated, it quickly collapses, wasting the project parties' funds and potentially triggering legal risks.

Worse still, some market makers serve multiple projects at the same time, which may lead them to favor large clients, deliberately lowering the prices of smaller projects, or transferring funds between different projects, resulting in a "one side gains while the other side loses" effect, causing significant losses for smaller projects. These behaviors exploit the loopholes in the regulation of the crypto market and the weaknesses of project teams due to lack of experience, ultimately leading to a significant shrinkage in project market value and a collapse of community confidence.

The Response Strategies of Traditional Financial Markets

Traditional financial markets------such as stocks, bonds, and Futures------have also faced similar challenges. For example, "Bear Market Attack" profits from short selling by massively dumping stocks to depress stock prices. High-frequency trading firms sometimes leverage ultra-fast algorithms to gain an edge during market making, amplifying market volatility for personal gain. In the over-the-counter (OTC) market, lack of transparency also provides unfair pricing opportunities for some market makers. During the 2008 financial crisis, some hedge funds were accused of exacerbating market panic through malicious short selling of bank stocks.

However, traditional markets have developed a relatively mature set of coping mechanisms that 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 available to borrow before short selling to prevent "naked short selling." The "up-tick rule" stipulates that short selling is only permitted when stock prices are rising, thereby restricting malicious price suppression. Market manipulation is explicitly prohibited, and violations of Section 10b-5 of the Securities Exchange Act may result in 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 authorities, and trading data (including prices and trading volumes) is made public, allowing investors to view it through professional terminals. Large transactions must be reported to prevent secret "dumping" behaviors. This high level of transparency effectively curbs improper actions by market makers.

3. Real-time monitoring: The exchange uses algorithms to monitor the market in real-time. Once abnormal fluctuations or trading volumes are detected, such as a stock suddenly plummeting, it will trigger an investigation mechanism. The circuit breaker mechanism is also widely applied, automatically pausing trading during excessive price fluctuations to provide the market with a cooling-off period and prevent panic from spreading.

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 qualification.

5. Protecting Investors: If market makers disrupt market order, investors can hold them accountable through class action lawsuits. After the 2008 financial crisis, several banks were sued by shareholders for market manipulation. The Securities Investor Protection Corporation (SIPC) also provides a certain degree of compensation for losses caused by broker misconduct.

Although these measures are not perfect, they have indeed effectively reduced predatory behavior in traditional markets. The core experience of traditional markets lies in the organic combination of regulation, transparency, and accountability mechanisms, creating a multi-layered protective network.

Vulnerability Analysis of the Crypto Market

Compared to traditional markets, the crypto market appears to be more fragile, mainly due to:

1. The regulatory system is not mature: Traditional markets have over a hundred years of regulatory experience, and the legal system is relatively sound. However, the global regulatory situation in the crypto market is still fragmented, with many regions lacking clear regulations regarding market manipulation or market maker behavior, providing opportunities for bad actors.

2. The market size is relatively small: The market capitalization and liquidity of cryptocurrencies still have a significant gap compared to mature stock markets. The actions of a single market maker can lead to drastic price fluctuations of a particular token, whereas large-cap stocks in traditional markets are less susceptible to such levels of influence.

3. Lack of experience from the project party: Many crypto project teams are dominated by technical experts and lack a deep understanding of the operation of financial markets. They may not fully recognize the potential risks of the loan options model and can easily be misled by market makers when signing contracts.

4. Lack of Transparency: The crypto market commonly uses confidentiality agreements, and the details of contracts are often kept strictly confidential. This practice has long been subject to regulatory scrutiny in traditional markets, but it has become the norm in the crypto world.

These factors work together, making small projects easy victims of predatory behavior, while also continuously eroding the trust foundation and healthy ecosystem of the entire industry.