Hidden Traps in the Crypto Market: How Loan Options Models Affect Small Projects

In the past year, the primary market of the crypto industry has been sluggish, with many projects facing severe challenges. In this "bear market" environment, some industry issues and regulatory loopholes have gradually come to light. Market makers should be the driving force behind new projects, supporting project development by providing liquidity and stabilizing prices. However, a collaboration model known as "Options model" may benefit all parties in a bull market, but has been abused by some bad 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 issues, but through mature regulation and transparent mechanisms, they have minimized negative impacts. The crypto industry can fully learn from the experiences of traditional finance to resolve the current chaos and build 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 market conditions.

Options Loan Model: Appearing Glamorous, 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 prices from fluctuating dramatically due to supply and demand imbalances. For emerging projects, collaborating with market makers is almost a necessary path, as it relates to whether they can smoothly launch on exchanges and attract investors. The "loan options model" is a common form of cooperation: the project side borrows a large number of tokens from market makers at no cost or low cost; market makers use these tokens to conduct market making activities on exchanges, maintaining market activity. Contracts usually include options clauses that grant market makers the right to return tokens at an agreed price or to buy them directly at specific future points in time, but do not require execution.

On the surface, this model seems to achieve a win-win situation: the project team gains market support, and 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 team and the market makers, providing opportunities for some dishonest market makers. They may use the borrowed tokens to disrupt the market instead of supporting the project, prioritizing their own interests.

Predatory behavior: How projects are victimized

When the loan options model is abused, it can cause serious damage to the project. The most common tactic is "market dumping": market makers sell a large number of borrowed tokens in a concentrated manner, leading to a rapid price drop. Retail investors see the situation deteriorating and follow suit in selling, triggering market panic. Market makers can profit from this, for example, by using "short selling" operations—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, earning a huge price difference. Alternatively, they may exploit the options terms to "return" tokens at the lowest price, achieving arbitrage at extremely low costs.

This kind of operation often has a devastating impact on small projects. There are multiple cases showing that token prices can plummet significantly in a short period, with market capitalization rapidly evaporating, making project refinancing nearly impossible. Worse still, the lifeline of crypto projects lies in community trust; once the price collapses, investors either view the project as a "scam" or completely lose confidence, leading to the disintegration of the community. Exchanges have certain requirements for the trading volume and price stability of tokens, and a price crash can directly lead to the delisting of the token, leaving the project in dire straits.

What exacerbates the situation is that these cooperation agreements are often tightly protected by non-disclosure agreements (NDAs), making it difficult for outsiders to understand the specific details. Project teams are mostly composed of individuals with technical backgrounds, and their understanding of the financial market and contract risks is relatively limited. When facing experienced market makers, they often find themselves at a disadvantage and may unknowingly sign agreements with potentially huge risks. This information asymmetry makes small projects ideal targets for predatory behavior.

Other Potential Risks

In addition to lowering token prices and abusing option terms through the "Loan Options Model", market makers in the crypto market have other means that may harm inexperienced small projects. For example, they may engage in "wash trading" operations, trading with each other using their own accounts or related accounts to create false trading volumes and attract retail investors. Once this operation stops, trading volume may plummet, leading to a price crash, and the project may even face the risk of being delisted by exchanges.

The contract may also hide some unfavorable terms, such as high margin requirements, unreasonable "performance bonuses," and even allowing market makers to acquire tokens at low prices and sell them at high prices after listing, causing a price crash and losses for retail investors, while the project party also has to bear responsibility. Some market makers may use information advantages to learn important project news in advance, engage in insider trading, induce retail investors to buy when prices rise, and then sell off in large quantities, or spread false information to drive down prices for low-cost acquisitions.

Liquidity "kidnapping" is another serious issue, where market makers may exploit the project's reliance on their services, threatening to raise fees or withdraw funds. If the project does not agree to renew the contract, it may face the risk of being smashed in the market. Some market makers also promote "package" services, including marketing, public relations, price manipulation, etc., but these services may merely create a false prosperity, ultimately leading to a price collapse and causing more trouble for the project.

Moreover, some market makers may serve multiple projects simultaneously, favoring large clients, intentionally lowering the prices of smaller projects, or transferring funds between different projects, resulting in a "rise of one and fall of another" effect, causing losses for smaller projects. These behaviors exploit the regulatory gaps in the crypto market and the weaknesses of inexperienced project teams, which may lead to a significant shrinkage in project market value and community disbandment.

Coping Strategies of Traditional Financial Markets

The traditional financial market------including stocks, bonds, and futures------has also faced similar challenges. For example, a "bear market attack" profits from short selling by driving down stock prices through massive sell-offs. High-frequency trading firms sometimes take advantage of ultra-fast algorithms to gain an edge during market making, amplifying market volatility for their own benefit. In the over-the-counter (OTC) market, the lack of transparency also provides some market makers with opportunities to manipulate quotes. 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 that is worth learning from for the encryption industry. Here are several key aspects:

1. Strict regulation: The U.S. Securities and Exchange Commission (SEC) has established Rule SHO, which requires that stocks must be available for borrowing before engaging in short selling to prevent "naked short selling" practices. The "Up-Tick Rule" allows short selling only when stock prices are rising, limiting malicious price suppression. Market manipulation is explicitly prohibited, and violations of Section 10b-5 of the Securities Exchange Act may face severe penalties, including hefty fines and criminal liability. The EU's Market Abuse Regulation (MAR) also specifically targets price manipulation practices.

2. Information Transparency: Traditional markets require listed companies to report the agreements with market makers to regulatory agencies, and trading data (such as prices and volumes) is made public. Ordinary investors can access this information through professional terminals. Large transactions must be reported to prevent secret "dumping" actions. This transparency greatly restricts the misconduct of market makers.

3. Real-time monitoring: The exchange uses algorithms to monitor the market and will immediately initiate an investigation upon detecting abnormal fluctuations or trading volumes. The circuit breaker mechanism automatically suspends trading during sharp price fluctuations, providing the market with a cooling-off period to prevent the spread of panic.

4. Industry Regulations: 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.

5. Investor Protection: 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) provides certain compensation for losses caused by the improper actions of brokers.

These measures, while not perfect, have indeed significantly reduced predatory behavior in traditional markets. The core experience of traditional markets lies in the organic combination of regulation, transparency, and accountability mechanisms, which has built a multi-layered protection system.

Vulnerabilities of the crypto market

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

1. Regulatory Immaturity: Traditional markets have over a hundred years of regulatory experience, and their legal systems are relatively well-established. In contrast, the global regulatory landscape of the crypto market is uneven, with many regions lacking clear regulations against 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 the US stock market. The operations of a single market maker can have a substantial impact on the price of a particular token, while large-cap stocks in traditional markets are not as easily manipulated.

3. Insufficient experience of the project party: Many crypto project teams are primarily composed of technical experts and lack in-depth understanding of the operation of financial markets. They may not fully recognize the potential risks of loan options models and can be easily misled by market makers when signing contracts.

4. Opaque Practices: The crypto market commonly uses confidentiality agreements, and the details of contracts are often not disclosed to the public. This secrecy has long been subject to strict scrutiny by regulatory agencies in traditional markets, but it has become the norm in the crypto world.

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