Risks in the Crypto Assets Market: Traps of the Loan Options Model

Over the past year, the primary market for Crypto Assets has been sluggish, with many projects facing severe challenges. Some inherent issues in the industry and regulatory loopholes have also been exposed. In theory, market makers should be a boost for new projects, helping them develop by providing liquidity and stabilizing prices. However, a collaborative approach known as the "Loan Options Model" may benefit both parties in a bull market, but has been abused by some bad actors in a bear market, causing serious harm to small Crypto projects, leading to a collapse of trust and market chaos.

Traditional financial markets have faced similar issues in the past, but through improved regulation and transparency mechanisms, the negative impacts have been minimized. The Crypto Assets industry can draw lessons from traditional financial markets to address existing problems 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 market conditions.

Options Loan Model: Surface Glossy, Hidden Risks

In the Crypto Assets market, the role of market makers is to ensure there is sufficient trading volume by frequently trading tokens, preventing prices from fluctuating sharply due to supply and demand imbalances. For emerging projects, collaborating with market makers is almost a necessary path; otherwise, it is difficult to get listed on exchanges or attract investors. The "loan Options model" is a common collaboration model: project parties borrow large amounts of tokens from market makers at low or no cost; market makers use these tokens to conduct market-making operations on exchanges, maintaining market activity. Contracts usually include Options clauses that allow market makers to return 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 allow both parties to win: the project party 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. 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 the development of the project.

Predatory Behavior: How Projects Get into Trouble

When the loan options model is abused, it can cause serious damage to the project. The most common tactic is "dumping": market makers sell a large number of borrowed tokens to the market in a short period, causing the price to plummet. Retail investors sense the danger and follow suit, leading the market into panic. Market makers can profit from this, for example, through "short selling"—selling tokens at a high price first, and then buying them back at a low price after the price collapse to return to the project, thus earning the price difference. Alternatively, they may take advantage of the options terms to "return" tokens at the lowest price, achieving profits at a very low cost.

This operation is devastating for small projects. There are numerous cases showing that the token price can be halved in just a few days, with market value evaporating sharply, and the opportunity for project refinancing basically lost. Worse still, the lifeline of encryption projects lies in community trust. Once the price collapses, investors either deem the project 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 sharp price drop may directly lead to the token being delisted, casting a shadow over the project's prospects.

What makes matters worse is that these cooperation agreements are often tightly protected by non-disclosure agreements (NDAs), making it difficult for outsiders to understand the specific details. Most project team members come from a technical background and lack experience in financial markets and awareness of contractual risks. When faced with experienced market makers, they often find themselves at a disadvantage and may not even be aware of the risk clauses they have signed. This information asymmetry makes small projects easy victims of predatory behavior.

Other Potential Risks

In addition to the practice of selling borrowed tokens to drive down prices and abusing Options terms for low-price settlements in the loan Options model, market makers in the Crypto Assets market also engage in other unethical behaviors specifically targeting inexperienced small projects. For instance, they may engage in "wash trading," using their own accounts or affiliated accounts to trade with each other, creating false trading volumes to make the project appear highly popular and attract retail investors. However, once this operation stops, trading volume quickly drops to zero, leading to a price collapse, and the project may even face the risk of being delisted from exchanges.

Contracts often hide some unfavorable terms, such as high margin requirements, unreasonable "performance bonuses," and even allowing market makers to acquire tokens at low prices, only to sell them at high prices after the project goes public, causing immense selling pressure, leading to a price crash, resulting in losses for retail investors, while the project party bears the blame. Some market makers also take advantage of information asymmetry, gaining advance knowledge of favorable or unfavorable news about the project to conduct insider trading, inducing retail investors to buy in when prices rise and then selling off, or spreading rumors to depress prices before buying in large quantities.

Moreover, some market makers may implement liquidity "kidnapping" against project parties. After the project parties become dependent on their services, they threaten to raise prices or withdraw funds. If the project parties do not renew the contract, they threaten to crash the market, putting the project parties in a dilemma. Some market makers also promote "one-stop" services, including marketing, public relations, and price manipulation. In reality, these services may be based on fake traffic, leading to a temporary price spike followed by a rapid collapse. The project parties not only incur huge costs but may also face legal risks.

Even more seriously, some market makers provide services for multiple projects simultaneously, which may lead to favoritism towards large clients, intentionally lowering the prices of smaller projects, or transferring funds between different projects to create the illusion of "one rising while the other falls," resulting in losses for smaller projects. These practices fully exploit the regulatory loopholes in the Crypto Assets market and the weaknesses of inexperienced project teams, ultimately causing significant shrinkage in project market value and a collapse of community confidence.

Traditional Financial Markets: Similar Issues, Better Solutions

Traditional financial markets, such as stocks, bonds, and futures markets, have also faced similar challenges. For example, a "bear market attack" involves a massive sell-off of stocks to drive down prices, followed by profiting from short selling. High-frequency trading firms sometimes exploit ultra-fast algorithms to gain a market edge during market-making, amplifying market volatility for personal gain. In the over-the-counter (OTC) market, information opacity also provides certain market makers with opportunities for unfair pricing. During the 2008 financial crisis, some hedge funds were accused of maliciously shorting bank stocks, exacerbating market panic.

However, traditional markets have accumulated rich experience in dealing with these issues, which is worth learning from for the crypto assets industry. Here are several 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" practices. There is also a "price increase rule" that allows short selling only when stock prices are rising, limiting malicious price suppression actions. 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 actions.

2. Information Transparency: Traditional markets require listed companies to report the content of agreements with market makers to regulatory authorities, and trading data (such as prices and volumes) is also publicly accessible. Ordinary investors can view this information through financial information terminals. Any large trades must be reported to prevent secret "dumping" actions. This level of transparency significantly reduces the risk of misconduct by market makers.

3. Real-time monitoring: The exchange uses algorithms to monitor the market in real-time. When abnormal price fluctuations or trading volumes are detected, such as a certain stock suddenly dropping significantly, an investigation procedure will be triggered immediately. A circuit breaker mechanism is also widely applied; when price fluctuations exceed a certain threshold, trading will automatically pause, providing the market with a cooling-off period to prevent further 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 stringent capital and conduct requirements, or they will lose their qualification.

5. Investor Protection: If the behavior of market makers disrupts market order, investors can seek compensation through class action lawsuits. After the 2008 financial crisis, several banks were sued by shareholders for market manipulation. In addition, the Securities Investor Protection Corporation (SIPC) provides a certain level of compensation for losses caused by broker misconduct.

Although these measures are not flawless, they have indeed significantly reduced predatory behavior in traditional markets. The core experience of traditional markets lies in the organic integration of regulation, transparency, and accountability mechanisms, which have constructed a multi-layered safety net.

Analysis of the Vulnerability of the Crypto Assets Market

Compared to traditional financial markets, the Crypto Assets market appears to be more fragile, mainly due to the following reasons:

1. The regulatory system is immature: Traditional markets have over a century of regulatory experience, and their legal systems are relatively sound. In contrast, the global regulatory landscape for crypto assets remains uneven, with many regions lacking clear regulations against market manipulation or market maker activities, providing opportunities for bad actors.

2. The market scale is relatively small: The total market value and liquidity of Crypto Assets 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 certain coin, while large-cap stocks in traditional markets are not easily manipulated.

3. Lack of experience from the project party: Many crypto assets project teams are primarily composed of technical experts, lacking in-depth understanding of how financial markets operate. They may not be aware of the potential risks in the loan options model and can easily be misled by market makers when signing contracts.

4. Lack of Transparency: The cryptocurrency market generally uses confidentiality agreements, and the details of contracts are often not made public. This secrecy has long been strictly regulated in traditional markets, but it is the norm in the world of crypto assets.

These factors combined make small projects easy victims of predatory behavior, while gradually eroding the trust foundation and healthy ecology of the entire industry. To address these issues, the Crypto Assets market needs to learn from the successful experiences of traditional financial markets, establish a more complete regulatory system, improve market transparency, and strengthen education for project parties and investors to create a fairer and healthier market environment.