Crypto Traps in a Bear Market: Predatory Tactics of Market Makers and Lessons from Traditional Finance
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Crypto Traps in a Bear Market: Predatory Tactics of Market Makers and Lessons from Traditional Finance
The crypto industry can certainly learn something from traditional finance.
Navigating Web3 tides with focused insightsBy Aiying
Over the past year, the crypto industry's primary market has been in a slump—almost like going back to square one. During this "bear market," human nature and the regulatory gaps of "decentralization" have been fully exposed. Market makers, who should be allies to new projects by providing liquidity and stabilizing prices, are instead increasingly abusing a cooperation model known as the "loan option model." While this arrangement often worked well during bull markets, it’s now quietly harming smaller crypto projects amid downturns, causing collapses in trust and market chaos. Traditional financial markets have faced similar issues, but thanks to mature regulation and transparent mechanisms, they’ve minimized the damage. In my view, the crypto industry can learn valuable lessons from traditional finance to fix these problems and build a fairer ecosystem. This article will dive deep into how the loan option model works, how it harms projects, what we can learn from traditional markets, and an analysis of the current situation.
1. The Loan Option Model: Sounds Good, But Full of Pitfalls
In the crypto market, market makers ensure sufficient trading volume by frequently buying and selling tokens, preventing sharp price swings caused by illiquidity. For early-stage projects, partnering with a market maker is almost essential—otherwise, listing on exchanges and attracting investors becomes extremely difficult. The "loan option model" is a common form of collaboration: the project lends a large number of tokens to the market maker, typically for free or at very low cost. The market maker then uses these tokens to provide liquidity on exchanges, keeping the market active. Contracts often include an option clause allowing the market maker to return the tokens at a predetermined price at a future date—or even buy them outright—but crucially, they retain the right *not* to do so.
On the surface, this seems like a win-win: the project gains market support, while the market maker earns trading spreads or service fees. But the problem lies in the "flexibility" of the option clause and the lack of contract transparency. Information asymmetry between the project team and the market maker creates loopholes that unscrupulous players can exploit. Instead of supporting the project, some market makers use borrowed tokens to manipulate the market, prioritizing their own profits above all else.
2. Predatory Practices: How Projects Get Exploited
When abused, the loan option model can severely damage projects. A common tactic is "dumping": the market maker floods the market with borrowed tokens, instantly crashing the price. Retail investors panic and start selling too, triggering a full-blown market collapse. Meanwhile, the market maker profits—by shorting, for example: selling tokens at high prices first, then buying them back cheaply after the crash to return to the project, pocketing the difference. Or, they may use the option clause to “return” tokens at rock-bottom prices, settling their obligations at minimal cost.
This kind of manipulation can be devastating for small projects. We've seen numerous cases where token prices halve within days, wiping out market capitalization and making future fundraising nearly impossible. Worse still, community trust—the lifeblood of any crypto project—is shattered. When prices collapse, investors either suspect the project is a scam or simply lose faith, leading to community disintegration. Exchanges require stable trading volumes and price performance; a sharp decline could lead to delisting, effectively killing the project.
To make matters worse, these agreements are often buried under non-disclosure agreements (NDAs), hiding critical details from public view. Many project teams consist of technical founders who lack experience in financial markets and contract risks. Facing seasoned market makers, they’re easily led into signing exploitative contracts without realizing the traps they're walking into. This imbalance turns small projects into easy prey for predatory behavior.
3. Other Traps in the Market
Beyond the loan option model, we’ve also encountered many client reports highlighting other tactics used by crypto market makers to exploit inexperienced small projects. For instance, some engage in "wash trading"—using their own accounts or "sock puppets" to trade among themselves, fabricating artificial volume to create the illusion of activity and lure retail investors in. Once they stop, volume vanishes overnight, prices crash, and projects risk being delisted.
Contracts often hide "invisible knives": excessive margin requirements, absurd "performance bonuses," or clauses letting market makers acquire tokens cheaply before dumping them post-listing, creating massive sell pressure that crashes prices—leaving retail investors devastated and projects blamed. Some market makers leverage information advantages, front-running project news (positive or negative) for insider trading, pumping prices to dump on retail buyers, or spreading rumors to suppress prices and accumulate cheaply.
Liquidity "hostage-taking" is even more ruthless: market makers make projects dependent on their services, then threaten to raise fees or withdraw unless renegotiated—warning that non-renewal means they’ll dump the token, leaving the project helpless. Others push "full-service packages" including marketing, PR, and price manipulation—sounding professional but delivering only fake traffic and pump-and-dump schemes, costing projects heavily while bringing trouble. Worse, some market makers serve multiple projects simultaneously, favoring big clients by deliberately suppressing smaller ones’ prices or shifting capital between projects to create artificial "winners and losers," leaving small teams financially gutted.
All these practices exploit regulatory blind spots and the inexperience of project teams, resulting in evaporated valuations and broken communities.
4. Traditional Finance: Similar Issues, Better Solutions
Traditional financial markets—such as equities, bonds, and futures—have faced similar challenges. For example, "bear raids" involve aggressively selling shares to drive down stock prices and profit from short positions. High-frequency trading firms, while acting as market makers, sometimes use ultra-fast algorithms to gain unfair advantages, amplifying volatility for their own gain. In over-the-counter (OTC) markets, opacity enables certain market makers to offer unfair quotes. During the 2008 financial crisis, some hedge funds were accused of exacerbating market panic by maliciously shorting bank stocks.
However, traditional markets have developed robust systems to address these issues—lessons the crypto industry should seriously consider:
Strict Regulation: In the U.S., the Securities and Exchange Commission (SEC) enforces Regulation SHO, requiring traders to locate shares before shorting, preventing "naked short selling." The "uptick rule" allows short sales only when the price is rising, limiting predatory price suppression. Market manipulation is strictly prohibited; violations of SEC Rule 10b-5 can result in ruinous fines or even prison. The EU has similar frameworks like the Market Abuse Regulation (MAR) targeting price manipulation.
Transparency: Public companies must report agreements with market makers to regulators. Trading data—including prices and volumes—is publicly accessible. Retail investors can monitor real-time data via platforms like Bloomberg Terminals. Large trades must be disclosed, preventing covert dumps. This transparency deters misconduct.
Real-Time Monitoring: Exchanges deploy algorithmic surveillance to detect anomalies such as sudden price drops or unusual volume spikes, triggering investigations. Circuit breakers pause trading during extreme volatility, giving the market time to stabilize and preventing panic-driven cascades.
Industry Standards: Bodies like the Financial Industry Regulatory Authority (FINRA) set ethical guidelines for market makers, mandating fair pricing and market stability. On the NYSE, Designated Market Makers (DMMs) must meet strict capital and conduct standards—or lose their license.
Investor Protection: If market makers disrupt markets, investors can file class-action lawsuits. After 2008, several banks faced litigation from shareholders over market manipulation. The Securities Investor Protection Corporation (SIPC) offers limited compensation for losses due to broker misconduct.
While not perfect, these measures have significantly reduced predatory behavior in traditional finance. The key takeaway? Traditional markets combine regulation, transparency, and accountability into a multi-layered defense system.
5. Why Is the Crypto Market So Vulnerable?
I believe the crypto market is far more fragile than traditional finance for several reasons:
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Immature Regulation: Traditional markets benefit from over a century of regulatory development and comprehensive legal frameworks. Crypto, however, faces a fragmented global landscape—with many jurisdictions lacking clear rules against market manipulation or governing market makers. Bad actors thrive in this gray zone.
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Small Market Size: The market cap and liquidity of most cryptocurrencies pale in comparison to major U.S. stocks. A single market maker’s actions can drastically move a token’s price—something nearly impossible with large-cap equities.
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Inexperienced Teams: Many crypto project founders are tech-savvy but financially naive. They may not understand the risks embedded in loan option models and get misled during contract negotiations.
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Culture of Secrecy: Heavy reliance on NDAs keeps contract terms hidden. In traditional markets, such opacity would raise red flags with regulators—but in crypto, it’s standard practice.
These factors collectively turn small projects into targets for exploitation, gradually eroding trust and damaging the overall health of the industry.
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