How are the dealers 'controlling the market' to harvest retail investors through funding rates?
I have already placed a simple flowchart on the cover.
Here we discuss a common strategy for manipulating spot and contract prices, which may involve either the project team's own market value management team, professional market makers, or large speculative investors with substantial capital. Therefore, the following text will uniformly refer to them as 'dealers' using a term that everyone prefers.
Everyone should have recently seen some unreasonable situations in various small-cap cryptocurrencies (#pippin #folks etc.)
situation
1: Low on-chain and spot trading volume, but high contract trading volume.
2: Prices are soaring, but trading volume is gradually declining?
3: The buy-sell ratio of orders between the spot and futures is completely opposite, producing a negative funding rate.
Example
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, who suddenly buys all the buildings in my development. The pricing power only exists between me and A; we are the supply and demand sides that influence housing prices.
Although B is not the homeowner, he believes that the housing prices in this development will fall. Therefore, B takes out 1 million to bet against A, believing that A's investment will definitely lose money. However, B is very likely to fail because the circulation price of the house is controlled by me and A, and our transactions will actually affect the circulation price. As long as me and A agree on the transaction price, B will definitely lose. The bet between B and A is similar to a derivative transaction and will not affect the circulation price of the spot.
Even if B believes that housing prices are artificially high and only worth 1 yuan/square meter, it cannot be realized because his transaction is not a spot transaction but a derivative transaction. Derivative trading bets on the spot price, so those who control the spot price (me and A) can largely determine the derivative transactions.
In the above example, the real estate developer is the project party, A is the 'market maker' who controls the spot circulation, and B is the contract user.
This is also why I say I have always felt that naked short selling is a very dangerous behavior.
Some essential basic knowledge of contracts
1: What are the marked price and the latest transaction price of a contract?
A contract has two prices: the latest transaction price and the marked price. Users generally default to using the latest transaction price when buying and selling. However, liquidation uses the marked price, which is calculated based on the latest spot transaction price to objectively reflect the price situation.
You can check Binance's announcements regarding this aspect.
In short, as long as the spot price is controlled, the marked price can be controlled, thereby controlling whether the contract market is liquidated.
Knowledge point 2: What is the funding rate of a contract?
The latest contract transaction price, in order not to deviate from the latest spot transaction price, will be adjusted every 8 hours through funding fees paid by long position users to short position users, or vice versa, and will also narrow the gap between the latest spot transaction price and the latest contract transaction price.
Calculation logic:
Positive funding rate: contract price > spot price (market sentiment is bullish). At this point, long positions (buyers) pay fees to short positions (sellers).
Negative funding rate: contract price < spot price (market sentiment is bearish). At this point, short positions (sellers) pay fees to long positions (buyers).
Settlement cycle: usually settles once every 8 hours (some exchanges or specific coins may settle faster).
Knowledge point 3: Why is the funding rate settlement cycle sometimes 8 hours, sometimes 4 hours, and sometimes 1 hour? Who decides this?
The ratio that determines the funding rate and the settlement time is decided by the exchange, but there is usually an automatic adjustment mechanism. The market makers of small coins are familiar with this automatic adjustment mechanism and have utilized it, and of course, the possibility of exchanges participating in harvesting cannot be ruled out (although it is a low probability event).
In other words, the original intention of the funding rate was to adjust the price difference between spot and contracts, but now it has become a tool for evil market makers to manipulate small coins and harvest retail investors. From now on, there are unreasonable aspects, at least in easily manipulated small coins.
4. The process of controlling small market cap contracts
Step 1: Find a project with a relatively low circulating market value and has opened a contract on a centralized exchange.
Generally, projects with circulating market values between 1 ~ 10M USDT will be chosen.
Step 2: Raise funds, funds > external circulating market value
If the market maker obtains a small project of 5M at a low price with 60% of the circulating supply (in fact, many controlled markets are now above 90%, more tightly controlled, but 60% is enough), at this time, it only requires approximately 2M USDT and 3M coins that are not moved, to fully control the spot and contract prices of this coin.
Step 3: Control the spot market price
As long as 3M coins are not sold, the spot market can have at most 2M of sell orders. Therefore, as a 'market maker' who wants to manipulate the coin price, one would need to prepare 2M USDT to maintain the spot price.
It is obvious that even if the 'market maker' sells all the tokens they hold outside at the same time, the price will not drop.
Step 4: Control the marked price of the contract
It was also mentioned earlier that the marked price of the contract is the spot price of various exchanges, which means that the marked price of the contract does not move.
Step 5: Open long positions in contracts
After ensuring that the marked price is controlled, use your own funds to open any leveraged position in the contract. It can be prudent to open a bit lower or aggressively a bit higher — it doesn't matter, anyway, the marked price has been controlled, and the market maker's long position will never be liquidated.
Step 6: Fund raising or using small accounts for counter trading
For coins with low depth and small market caps, raising the price by 100% in the spot market does not require much funding. If it cannot be raised, one can open a small account and place a high sell order at +100% price, and once executed, it will naturally show as a +100% rise in the last 24 hours.
After seeing this news, retail investors will flood in, leading to a large demand for shorting, and of course, a small number will go long.
Not afraid of you making money, just afraid you don’t play >>>
Step 7: Use funding rates to stabilize profits
At this time, there are very few sell orders in the spot order book, but there are many short positions in the contracts, which causes the spot price to be higher than the contract price, resulting in a negative funding rate. The greater the gap, the more negative the funding rate, meaning that even if the marked price does not change, short sellers have to pay a high funding fee to long positions every 8 hours (or even now small coins may fluctuate violently, making the funding rate change to 4 hours or 1 hour).
The market maker continuously profits under this game mechanism through funding rates. To give a more extreme example, recently, pippin has a funding rate of 2% per hour. As long as the position is held unchanged for 24 hours, a 48% return can be obtained. Although it won't actually maintain this high rate, the average data is still terrifying.
Coincidentally, exchanges have also modified the funding rates, either manually or automatically, hoping to help narrow the price gap between the spot and contract markets. However, they have not found the root cause of the abnormal funding rates. Widening the funding rate range and shortening the settlement cycle does not solve this problem; instead, it helps project parties/market makers/institutional investors harvest retail investors.
Everyone has also noticed that the recent upward movement of#pipin ,#folks and so on, the contract funding rates have generally shown large negative numbers.
5. How market makers profit
First profit point: buy low and sell high in the spot market.
Please remember, being a market maker is not charity; the coins bought are neither gold nor BTC, and in the end, they must be profited through selling. The so-called pump is all for the subsequent dump.
Second profit point: contract funding rate.
Third profit point: mutual destruction of long and short, for retail investors chasing longs, every sudden drop during the rise, and for high shorts, the continuous unnoticed massive surge, funding fees force passive liquidation or liquidation.
After looking at the process, everyone can also see that the premise is to control the circulation of the spot coins. If it is a large number of linearly unlocked coins, it cannot be manipulated for a long time. Each unlocking will change the circulation.
6. Where is the problem?
Question 1: Can contract Open Interest exceed the spot circulating market value?
Contracts can be opened with only USDT, while spot requires coins to sell. Obtaining coins creates selling pressure in the spot market and shorting in the contract market; the difficulty of these two is not the same.
Returning to the third part, step three, the market-making user has already retrieved the coins in their hands. Even if some users believe that this coin is severely overpriced, they cannot create selling pressure in the spot market. At this point, users will turn to shorting in the contract market. In other words, users' trading inclination cannot be released in the spot market due to the low circulation, and they can only go short in the contract market.
Returning to the marked price in the second part. The marked price of the contract is the latest spot transaction price, which has been controlled by project parties/market makers/institutional investors. Therefore, how the contract is liquidated has also been controlled.
Therefore, when the contract OI > spot circulating market value, it means that due to the scarcity of the coin, users' trading demand cannot be reflected in the spot price. The excess contract OI will exacerbate the price deviation between spot and futures.
Question 2: When funding rates are abnormal, does widening the upper and lower limits of funding rates and shortening the settlement time really promote fairness?
Currently, the exchange's solution is to widen the funding rate and shorten the settlement cycle. On the surface, this solves the price difference between the spot and contract markets, but in reality, it enhances the ability of project parties/market makers/institutional investors to harvest retail investors. Generally, the current funding rate range at exchanges is [-2%, +2%], and further widening will actually increase the 'market maker's' earnings.
Therefore, although the existing funding rate mechanism helps to anchor the prices of the derivative market to the spot market prices, it does not help make the trading market fairer, and may instead promote the trading market becoming more unfair.
Question 3: Do exchanges now realize that there are fairness issues with the current funding rates? Is there a more reasonable way to respond to the manipulation and abuse of funding rates by market makers?
This question is left for everyone to discuss, or @CZ @Yi He to see if they have answers now???
7. How retail investors can hedge
Note 1: Be wary of projects with small market caps that have opened high-leverage contracts. This gives large players a very unequal competitive advantage compared to retail investors.
When users choose to buy in the spot market and open long positions in contracts, they accumulate enough buyers for project parties/market makers/institutional investors to gradually sell off and start harvesting retail investors again.
Note 2: Projects with high absolute values of funding rates
Note 3: The market maker does not do charity; the final source of income from raising the price must be made through crashing the price for profit.
Escape early, be careful not to become the market maker's scapegoat. When the thought of 'this coin is a value coin, I want to hold it long-term until the next bull market' arises, the market maker's crashing of the price is not far away. Their goal in raising the price is to cultivate this user psychology for their own acquisition.
In the small market cap contract market, trading against market makers is like playing poker with them, where they are both the players and the dealers.
So this article ends here; I hope that after reading this article, everyone can be less harvested by market makers and more from them.
If you think this writing is good, I want to gather 1000 fans to start a broadcast and talk about useful content (chat and share).
