Dealer's manipulation of prices revealed: How can retail investors avoid being played for suckers?

Original author: OwenJin 12 (X: @OwenJin12)

This article is not aimed at $P****. I just randomly picked a project with obviously abnormal data in the secondary market, which is more convenient for demonstration.

This article discusses a common strategy for manipulating the spot and contract coin prices, which may be the project's own market capitalization management team, professional market makers, or large investors with relatively large funds. Therefore, the following text uniformly refers to them as "dealer", which is a term that everyone prefers to use.

1. Simple process first.

2. Phenomenon

Have you often encountered the following unreasonable situations on the exchange?

Phenomenon 1: Low trading volume on-chain and spot, but high trading volume in contracts

Taking Gate as an example, the contract trading volume is about 60 times the spot trading volume.

Phenomenon 2: The price is rising but the volume is gradually decreasing?

The price keeps pumping, but the volume of transactions is decreasing, and the MACD is clearly showing a bearish divergence.

Phenomenon 3: The long and short ratios of spot and contract trading orders are completely opposite, resulting in a negative funding rate

The surge in prices has led to a collective bearish sentiment among users, but they don't have coins in hand to go short, so they can only open short orders in the futures market. As a result, the spot and futures markets have generated completely opposite market sentiments.

Completely opposite market sentiment has led to a funding rate of -0.66%, settling every 8 hours, so 24 hours would be -1.98%.

For example, trading derivatives (contracts) is like buying and selling houses. I am a real estate developer, and my houses mainly serve wealthy person A. A bought all the buildings in my development at once. The pricing power only exists between me and A, and we are the supply and demand sides that will affect housing prices.

While B is not the owner of the house, he believes that the price of this property will fall. Therefore, B puts out 1 million and wants to make a bet with A, believing that A's investment will definitely lose money. So B is unlikely to succeed because the market price of the house is controlled by me and A. The transactions between me and A will truly affect the market price. We just need to negotiate the transaction price between me and A, and B will definitely lose. The bet between B and A is similar to derivatives trading and will not affect the market price of spot.

Even if B thinks that the housing prices are overvalued and actually worth only 1 yuan/square meter, it is impossible to realize it, because his transaction is not a spot transaction, but a derivative transaction. And the derivatives trading is betting on the spot price, so the people who control the spot price (me and A) can largely determine the derivatives trading.

In the above example, the real estate developer is the project party, A is the 'dealer' who controls the spot circulation (and may control the spot price), and B is the contract user.

That's why it's often said that naked short selling in the derivatives market is a risky behavior.

3. Some Essential Contract Basics You Must Know

Knowledge Point 1: What are the mark price and last traded price of a contract?

A contract has two prices: the latest transaction price and the mark price. When users buy and sell, the latest transaction price is generally used by default. However, the mark price is used for liquidation. The mark price, in order to objectively reflect the price situation, is calculated using the latest transaction price of the external spot market through an algorithm.

Gate contract mark price explanation:

_logic/22067/instructions-of-dual-price-mechanism-mark-price-last-price

In other words, as long as the spot price is controlled, the mark price can be controlled, and thus whether the contract market will be liquidated can be controlled.

Point 2: What is the funding rate of the contract?

In order to keep the contract's latest transaction price anchored to the spot's latest transaction price, every 8 hours, it will be transferred between long position users and short position users in the form of funding fees, and the gap between the spot's latest transaction price and the contract's latest transaction price will be reduced.

Topic 3: What is the circulating market capitalization of a project?

The economic mechanism of a project depends on the white paper. It is generally divided into project parties, early investors, community airdrops, and project treasuries. If a project's white paper is not transparent enough, it is more likely to be manipulated. For example, although the white paper gives the community enough freedom, it also gives market makers/institutional investors enough freedom-they can freely acquire low-priced chips at low levels, and once acquired, they cannot be diluted because there is no issuance or linear unlocking mechanism.

4. Market Cap Control Process for Small Cap Contracts

Step 1: Find a project with relatively low market capitalization and has opened a contract on CEX

Generally, small projects with a market capitalization of 1 ~ 10 M USDT and a contract leverage ratio of 20 ~ 30 times are usually chosen.

Step 2: Raise funds, funds>external circulating market cap

Million-level speculative large investors, prefer to act as dealers in small market cap contracts. Taking $P**** as an example, with a circulating market cap of 5M. In a long downturn, if the dealer acquires 60% of the circulating supply at a low price, they only need to hold 2M USDT and 3M coins without moving them in order to fully control the spot and contract prices of this coin.

Step 3: Control spot order book price

As long as 3 M coins are not sold, there will be a maximum of 2 M sell orders in the spot order book. So as a 'dealer' who wants to manipulate the coin price, you will need to prepare 2 M USDT as the funds to maintain the spot price.

It is obvious that even if all $P**** outside the "dealer"'s hands are sold at the same time, the price will not fall.

Step 4: Control Contract Mark Price

As mentioned earlier, the mark price of the contract is the spot price of each exchange, which means that the mark price of the contract does not move.

Step 5: Open a long position in the contract

After ensuring that the mark price is under control, use your own funds to open leveraged positions in the contract. You can open positions with lower leverage for safety, or higher leverage for more aggressiveness - it doesn't matter, as the mark price has already been controlled and the dealer's long positions will never be liquidated.

Step 6: Pumping funds or trading with a small account.

For coins with low depth and small market capitalization, it doesn't take much funds to pump up the spot price by 100% in a day. If it cannot be pumped up, then open a new account and place a sell order at +100% of the price. After the transaction is completed, it will naturally show a recent 24-hour price change of +100% for that coin.

After seeing this news, retail investors will flock in and start generating a large amount of shorting demand.

Step 7: Making Stable Profits with Funding Rate

There are few sell orders in the spot order book at this time, but there are many short positions in the contract, which causes the spot price to be higher than the contract price and generates a negative funding rate. The larger the difference, the more negative the funding rate, which means that even if the mark price remains unchanged, the short positions have to pay a high funding rate to the long positions every 8 hours just for holding positions.

Under this game mechanism, the dealer continuously makes money through the funding rate. For example, SRM can earn 16% of profit by simply holding its position for 24 hours.

Coincidentally, recently exchanges have also frequently modified funding rates in an attempt to help narrow the spread between the spot market and the futures market. However, they have not found the fundamental cause of the abnormal funding rates. Expanding the rate range cannot solve this problem and may instead assist project parties/market makers/institutional investors in harvesting retail investors through funding rates.

Adjust LINA funding rate

Adjust MTL funding rate

Everyone will also notice that LINA and MTL were the pump coins in the recent period, and the funding rate of the contracts showed a significant negative number.

5. How does the dealer make a profit

First profit point: buy low and sell high in spot.

Please remember, market-making is not charity, and the coins you buy are not gold or BTC. In the end, profits must be made by selling. The so-called pump is always followed by a dump.

Second profit point: contract funding rate.

The third profit point: directly go to the leveraged lending market with the coins that are held without selling. For example, on Gate, you can put them in the Yield Bao to get an annualized return of 499% +.

After watching the process, everyone can also find that the premise is to control the circulation of the spot currency. If it is a coin with a large linear unlocking mechanism, it cannot be manipulated for a long time. Each unlocking will change the circulation.

6. What's the problem?

Question 1: Can the Open Interest of a contract exceed the spot market capitalization?

Contracts only require USDT to open positions, while spot trading requires coins to sell. Obtaining coins creates selling pressure in the spot order book, while shorting in the contract order book has a different level of difficulty.

Returning to the third part of the third step, the user who manipulates the market has already withdrawn the coins. Even if some users believe that this coin is significantly overvalued, they cannot create selling pressure in the spot order book. At this time, users will turn to shorting in the futures market. In other words, due to the issue of low circulating supply, users' trading preferences cannot be realized in the spot market and can only be expressed in the futures market through shorting.

Back to the mark price in the second part. The mark price of the contract is the latest transaction price of the spot, which has been controlled by the project party/market maker/institutional investors. Therefore, how the contract gets liquidated has also been controlled.

Therefore, when the contract OI> spot circulation market value, it means that due to the scarcity of coins, the trading demand of users cannot be reflected in the spot price. The excess contract OI will exacerbate the phenomenon of price deviation between the futures and spot markets.

Question 2: When the funding rate is abnormal, does expanding the upper and lower limits of the funding rate really promote fairness?

Currently, the solution adopted by exchanges to address the price difference between spot and futures markets is to expand the funding rate. This seems to solve the problem on the surface, but in reality, it only increases the ability of project parties/market makers/institutional investors to exploit individual investors. Generally, the funding rate range of exchanges is between [-2%, +2%], and further expansion will actually increase the profits of "dealers".

Therefore, although the existing funding rate mechanism helps to anchor the price of the derivative market to the spot market price, it does not help the trading market become fair and may even make the trading market more unfair.

7. How to hedge as a retail investor

Note 1: Be wary of projects with low market capitalization but high leveraged contracts. This gives large investors a significant competitive advantage over retail investors

When users choose to buy spot and open long contracts together, it allows the project party/market makers/institutional investors to accumulate enough buyers, so they can start selling in batches and harvest retail investors once again.

Attention 2: Projects with high absolute funding rates

**Point 3: Dealers do not do charity. The cost of pulling up the market must be recovered through dumping to make a profit in the end.

Fleeing early, be careful of becoming a dumb buyer for dealers. When the idea of "this coin is a value coin, I will hold it for the next bull run" appears, it is not far from the dealer dumping. The purpose of their pumping is to cultivate this user mentality to dumb buy for themselves.

Playing against a dealer in the small market cap contract market is like playing Texas Hold'em with him showing his cards. He is both a player and a dealer.