(Bloomberg) — On the day of one of the cryptocurrency market’s worst trajectories, Alex Holland woke up to a wave of messages from friends and family. They knew he had recently made a big bet that prices would fall.
But when he went to check his account on the online exchange Binance, he saw that the value of his leveraged bet against Ethereum was falling instead of making a profit several times larger than the declines in the second largest cryptocurrency. .
“I just kept blinking,” said the 59-year-old Canadian, who suffered a spinal cord injury after a skiing accident. “I thought it was just a bug and they would fix it.”
By the end of May 19, Ethereum would plummet by about 20% and the so-called downward token of the Netherlands dropped about 85%. The value was so low that it appeared as zero on price charts.
In a way, it’s a cautionary tale as old as Wall Street — retail speculators burned by Byzantine derivatives — amplified by a lack of regulation, erratic market remediation and the extreme volatility of the $1.3 trillion crypto world.
It’s hard to know exactly how much value has been wiped out. But a growing group of disgruntled Binance users are now organizing – with a combination of social media and legal threats – to put pressure on the exchange to make up for their losses. Regulators have also taken note, with Binance increasingly being monitored in Asia, North America and Europe.
The records of the Netherlands show that he put about $2,700 in the bearish tokens from April to May 19 through a series of trades. Including his previous trades, he estimates his total investment to be around $10,000.
Leveraged tokens are placed by crypto exchanges as an easy way for amateurs to place excessive bets without the hassle of managing collateral or margin requirements. On Binance, the product uses futures to provide long or short exposure to cryptocurrencies with a unique twist: a leverage ratio that hovers between 1.25 and 4 times. In theory, that means that a 20% dip in a coin should translate into a 25% to 80% gain.
The world’s largest crypto exchange touts unpredictability as a feature, not a bug, to avoid front-running. But it has also led traders to wonder how they are managed, especially during the manic swings that are also a hallmark of the market.
The experience of the Netherlands was typical on 19 May. Down tokens linked to the Litecoin and Tezos cryptocurrencies lost money despite betting on the right direction. Polkadot’s down token ended up being worth less than three cents, a 95% drop from the previous day. At one point, both the tokens that were trading on and against Ethereum had fallen by about 75%.
May 19 was generally a day of uproar, with crypto platforms including Binance and Coinbase disrupting regular trading after negative tweets from Elon Musk and tightening restrictions in China sent investors fleeing.
As more traders sought to cash in bearish leveraged tokens, Binance said the outflow caused the leverage ratio to spike in some cases. When the program had to cut its short position in a rocky and illiquid market to lower the ratio again, it ended up losing money due to market conditions.
In other words, the product had to maintain cutting positions at the worst time. That day, Ethereum downtokens were rebalanced 21 times, most of which lasted more than half an hour.
“However, we should note that there were no identifiable issues or errors with the BLVT during the period,” a spokesperson said in an email. “Binance users will be informed in advance of the risks associated with trading activities,” including through a training video and testing their understanding.
In the depths of the sell-off, the platform has suspended trading for most leveraged tokens. It now no longer allows tokens to be subscribed or exchanged during rebalancing.
The product is somewhat similar to exchange-traded leveraged funds, which are typically rebalanced at the end of each day to maintain a certain exposure. The difference is that the Binance tokens are only rebalanced when the leverage ratio goes outside the range of 1.25 to 4 and is based on a proprietary algorithm that determines the ratio.
One problem with the lack of regular rebalancing is that the product naturally gains leverage just as the market resists, warns Tim Leung, an applied mathematics professor at the University of Washington who has written a book on leveraged ETFs.
“It’s too opaque,” he said, generally commenting on a retail product structured this way. “An investor looks at the historical leverage ratio and thinks it should be 2x, but there is no guarantee that the future leverage ratio will be two.”
There is little that retailers can do through legal action. Binance operates as a constellation of entities in multiple jurisdictions, and its terms require any dispute to be resolved through individual arbitration in Hong Kong and cannot give rise to class action claims.
For the Netherlands, it is another blow to its longstanding trust in cryptocurrencies. After initially collecting some coins by running a crypto mining rig, he lost all the money he put into QuadrigaCX, a Canadian exchange that wiped out at least $125 million in customer money when it collapsed in 2019.
When it came to choosing another exchange, he thought he couldn’t go wrong with the biggest in the crypto world.
“It was a big, big amount of money for me that died, even though I predicted everything right,” he said from Calgary. “Given my situation, that was my only chance to retire and now it’s pretty much all gone.”
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