Web3 Lawyer: How Crypto Exchanges Exploit Token-Issuing Projects

In addition to the everyday operational challenges faced by traditional internet entrepreneurs, Web3 entrepreneurs face an additional "Hard Mode" challenge: token issuance.

To the uninformed public, the highlight moment for a Web3 project team is getting listed on an exchange, as it somewhat resembles becoming a "publicly listed company." However, the bittersweet reality of this process is likely understood only by those directly involved.

As a Web3 entrepreneur issuing tokens, you must not only guard against the risk of regulators deeming your activities as illegal securities offerings and ensure compliance through measures such as establishing overseas project structures and foundations, but also beware of being exploited by the very exchanges listing your tokens—a significant pitfall.

It is an industry convention that meme coins list on decentralized exchanges (DEXs), while serious projects list on centralized exchanges (CEXs). Crypto exchanges have become the preferred choice for many entrepreneurs issuing tokens, as listing confers prestige. However, unbeknownst to many, most crypto exchanges are merely makeshift operations, rife with the bugs and human risks typical of startups. The most common issue is that internal exchange employees may manipulate token prices through fake trading volumes to exploit both project teams and retail investors, making it difficult to guard against such practices.

Lawyer Liu Honglin from Mankun Law Firm will share insights into the "Dark Forest Laws" of the crypto exchange ecosystem based on his observations. This article aims to provide psychological reassurance and practical preventive advice for Web3 entrepreneurs preparing to list on exchanges.

Common Exploitative Tactics Used by Exchanges

Contrary to the perception among mainland Chinese peers that listing on the A-share market is extremely difficult, listing on a crypto exchange is generally not particularly challenging for Web3 project teams. As long as you have the financial capacity to pay sufficient listing fees, you can essentially navigate mainstream exchanges with ease.

Procedurally, first, the Web3 project team must liaise with the exchange's listing team, complete and submit a listing application, provide the project whitepaper, and introduce the project's objectives, technical solutions, team background, market analysis, and tokenomics model. Second, the project must provide test results and security audit reports, as well as a legal opinion issued by professional lawyers to confirm the legality and compliance of the token.

Regarding costs, Web3 project teams typically need to pay listing fees, which vary by exchange and range from tens of thousands to hundreds of thousands of US dollars. Additionally, fees for legal opinions and technical audits must be paid, ranging from a few thousand to tens of thousands of US dollars, depending on the complexity of the services and the provider's fee structure. Beyond basic listing fees, exchanges often devise various pretexts to extract additional value from Web3 project teams. For example, they may require the project team to provide a certain amount of tokens as market-making collateral to ensure liquidity in the crypto market and incentivize the exchange to provide a favorable trading environment. They may also require airdrops or conduct marketing campaigns to reward holders of the exchange's platform tokens upon listing.

Do you think these explicit charges constitute the entirety of a crypto exchange's revenue? No, there are also covert expropriations.

The primary reason is that CEXs, which trade these decentralized virtual assets, are themselves purely centralized companies. Those familiar with large centralized corporations know that issues such as data opacity, internal personnel manipulation, and conflicts of interest are inherent. As centralized platforms, exchanges possess vast amounts of trading data and user information, granting them strong market manipulation capabilities. Below are some common market manipulation tactics; arguably, there is always one that can exploit you.

1. Fabricating Fake Trading Volumes:"Excellent" exchanges do not solely exploit project teams; they choose to exploit retail investors as well. The most common method involves exchange employees or affiliated parties creating fake trading volumes through large numbers of buy and sell orders to attract more retail investors, thereby manipulating token prices. This practice is commonly known as "wash trading" or "volume spoofing." A previous report by the Blockchain Transparency Institute (BTI) indicated that over 80% of the trading volume among the top 25 global exchanges was fabricated through fake trading volumes. The report pointed out that the actual trading volume of certain exchanges was less than 1% of their reported volume. Shortly after the report's release, the head of a leading exchange reposted and commented: "This is the most accurate and profound ranking of crypto exchanges I have ever seen."

2. Data Manipulation:Operating under the principle of "my turf, my rules," exchanges can use backend privileges to directly modify trading data for specific projects, affecting the token's market performance. For example, they may manipulate key indicators such as candlestick charts and trading volumes to mislead investor decisions. Such operations are often conducted during periods of high market volatility to create false market impressions and induce investors to follow suit. Recently, Lawyer Honglin observed a newly listed project whose price was manipulated by a crypto exchange, showing abnormal data for several consecutive days. Many investors suspected that this was caused by internal trading and data manipulation by the exchange.

3. Insider Trading:Insider trading involves using undisclosed market information to obtain illegal profits. Exchange employees or affiliated parties may engage in preemptive buying or selling upon learning of significant market movements in advance, thereby securing substantial profits. For example, they might buy or sell relevant tokens before a new token launch or the release of major announcements. Earlier this year, in the BOME (Book of Meme) project, which achieved the fastest listing on a certain major exchange, media outlets suspected that exchange employees engaged in insider trading. Before the exchange issued its statement, an account withdrew SOL worth approximately USD 2.3 million from the exchange platform and purchased 314 million BOME at a price of USD 0.0074. After BOME was listed on the exchange, its price surged by over 1500%. The exchange subsequently launched an internal investigation, claiming that no internal employees were involved.

4. High-Frequency Trading and Arbitrage:Many exchanges operate their own trading teams or engage market-making service providers. They utilize high-frequency trading technology to execute trades at the millisecond level, capturing tiny price differences to accumulate arbitrage profits. High-frequency trading typically employs complex algorithms and high-performance computing equipment to complete a large number of transactions in an extremely short time. In 2017, an exchange garnered widespread attention due to a flash crash involving Ethereum (ETH). At that time, the price of Ethereum plummeted from USD 319 to USD 0.10 within seconds before rapidly rebounding. Subsequent investigations revealed that this extreme price volatility was triggered by high-frequency trading algorithms executing massive sell and buy orders during intense market fluctuations.

How Should Entrepreneurs Respond?

Reflecting on one's own shortcomings when problems arise is a prudent strategy for adults to survive. Since external factors are beyond our control, entrepreneurs must remain vigilant. In response to the aforementioned risks, Lawyer Honglin offers the following recommendations:

1. Choose Reputable Exchanges:When selecting an exchange, prioritize those with good reputations and transparent operations, avoiding emerging or obscure platforms. It is advisable for entrepreneurs to assess an exchange's credibility by reviewing public audit reports, user reviews, and ratings from third-party evaluation agencies. Additionally, communicate with other project teams to understand their actual experiences and feedback on different exchanges. Simultaneously, avoid listing your token on only one exchange, as this makes it easier for that exchange to engage in black-box operations and price manipulation.

2. Sign Detailed Listing Agreements:When signing a listing agreement with an exchange, clearly define the rights and obligations of both parties, particularly clauses regarding data transparency and operational compliance, to safeguard your interests. The agreement should include prohibitions against behaviors such as fabricating trading volumes and manipulating data, along with corresponding liabilities for breach of contract. Furthermore, require the exchange to provide regular trading data reports to facilitate independent audits by the project team.

3. Monitor Market Dynamics in Real Time:Utilize professional market analysis tools to monitor the token's market performance in real time, promptly identify abnormal trading activities, and take appropriate measures. It is recommended that entrepreneurs use multiple independent data sources for cross-verification to avoid relying on data from a single platform. Additionally, consider engaging third-party monitoring services to provide 24/7 market surveillance and risk alerts.

4. Engage Legal Counsel:The importance of a competent legal compliance advisory team is comparable to that of a market maker, a point often overlooked by many token-issuing project teams. A pragmatic recommendation is to engage lawyers with experience in the blockchain and cryptocurrency sectors to provide professional services once you prepare to issue tokens. Professional legal counsel specializing in the crypto industry can assist with legal matters related to exchanges, ensuring that all operations comply with legal requirements. They can participate in the drafting and review of listing agreements before listing, helping to identify potential legal risks, and take timely legal action if issues arise. More importantly, they can provide strategic advice on handling various unexpected incidents after listing, thereby mitigating unnecessary public relations crises.

5. Community Building and User Education:He who wins the community wins the world. Every successful Web3 project is backed by a solid user base. Enhancing community cohesion and shaping user investment preferences through online and offline events, educational content, and interactive exchanges is standard practice. During bullish markets, community members will naturally praise the project's success. However, during bearish markets, it is common for the community to react with anger, personal attacks, and threats to report the project to authorities for rights protection. Therefore, Lawyer Honglin often earnestly advises Web3 entrepreneurs to avoid making overly absolute statements in community communications, as these can become pitfalls later. In the event of sudden incidents, such as exploitation by an exchange or market maker, it is recommended to promptly synchronize event information on official media accounts to prevent user panic.

Conclusion

Overall, there are many seasoned predators eager to extract money from Web3 entrepreneurs. For entrepreneurs, in addition to facing legal and regulatory risks in different countries and regions, it is crucial to beware of pitfalls set by commercial partners such as crypto exchanges and market-making service providers. We hope this article clarifies the obstacles that centralized crypto exchanges may place in the entrepreneurial journey, helping you recognize these risks and approach token issuance and trading with greater caution and preparation. The path of entrepreneurship is inherently challenging; may everyone avoid these pitfalls and embrace greater opportunities and development.