The structural risks of the pre-market trading market: A look at the Hyperliquid platform XPL incident

Author: danny Source: X, @agintender

How whales take advantage of the right time, place, and people in $XPL's pre-market trading on Hyperliquid and harvest experts - that is, early holders hedge by short selling, thus forming a "crowded trade" and ultimately being detonated by the "ignition strategy" - is not an accidental market fluctuation, but a systemic risk caused by the structural flaws of the pre-market market. This article doesn't evaluate the ins and outs of the $XPL incident, but rather discusses some structural and systemic risks in the pre-market trading market. Every model has its advantages and disadvantages, and this isn't a matter of right or wrong. This article aims to highlight the risks and their causes. Section 1: A New Paradigm: Pre-Market Trading The core of pre-market trading (more accurately, "pre-launch trading") is the creation of a synthetic market for a token that has not yet been issued or publicly circulated. This is not a reaction to existing asset information, but rather a pure price discovery process for future assets. The underlying asset traded is not the token itself, but a futures contract, which can be spot, over-the-counter, or perpetual. This shift in mechanism fundamentally changes the nature of risk. While the primary risks of traditional pre-market trading are insufficient liquidity and increased volatility, the existence and fundamental value of the asset remain unquestioned. However, the pre-market cryptocurrency market introduces new risk dimensions: first, settlement or conversion risk. This risk involves the possibility that the project's tokens may never be issued, preventing the market from converting to a standard spot or perpetual contract market, potentially leading to suspension or delisting. Secondly, there's the risk of price anchoring. Without an external spot market to serve as a price reference, market prices are entirely determined by buying and selling activity within the platform, forming a self-referential closed loop that makes the market more susceptible to manipulation. Therefore, the innovation of pre-market cryptocurrency trading lies in creating a market out of thin air, but at the cost of creating a trading environment that is structurally more fragile and carries a wider range of risks. It's not that everyone is unaware of this risk, but exchanges can gain traffic, market makers can achieve "price discovery" in advance, and project owners and early investors can "hedge risks"—under the premise that all parties profit, everyone acquiesces to this arrangement (risk). Section 2: DEX Hedging: A Double-Edged Sword on a Tightrope 2.1 Rational Hedges: Why Early Holders Short Pre-Market Futures to Lock in Value Before a new token's TGE, early holders (including private investors, team members, and airdrop recipients) face a common dilemma: they hold tokens or token claims that are not yet circulated and cannot be traded, but the value of these future assets is exposed to significant market uncertainty. Once the token goes public, its price may be far lower than expected, resulting in a significant reduction in paper wealth. The pre-market futures market provides a near-perfect solution to this dilemma. By shorting an equivalent amount of perpetual contracts in the pre-market market, holders can lock in the future selling price of their tokens in advance. For example, if a user expecting to receive 10,000 airdrop tokens is trading at $3 in the pre-market futures market, they can hedge their risk by shorting 10,000 contracts. Regardless of the spot price at the time of the TGE, their total profit will be locked in at approximately $30,000 (ignoring transaction costs and basis). This operation essentially creates a delta-neutral position: the risk of their long spot position (holding the pending airdrop) is offset by their short futures position (shorting the perpetual swap). For any rational risk-averse investor, this is a standard and sensible financial strategy. 2.2 Formation of a Crowded Trade: When Collective Hedging Creates Concentrated Vulnerability A "crowded trade" arises when a large number of market participants trade based on similar logic, at the same time, and using the same strategy. This risk stems not from asset fundamentals (exogenous risk), but rather from the high correlation between the behavior of market participants—an endogenous risk. If you've seen the ALPACA episode before, you'll know that this operation is all about "market consensus"—where there's market consensus, there's direction; where there's direction, there's opportunity; where there's opportunity, there's speculation. In the pre-market, this crowding phenomenon is structural and predictable. The nature of airdrops and early token distributions creates a large, homogeneous group (i.e., token recipients) who, at the same point in time (before the TGE), face the same exact risk exposure and have the same anticipatory motivation (shorting). Meanwhile, the group of speculators willing to take the risk and buy these futures contracts is relatively small and dispersed. This natural imbalance between long and short positions inevitably leads to extreme market crowding in the short direction, creating a classic case of crowded shorts. The greatest danger of crowded trades lies in their fragility. Since the vast majority of people are on the same side of the boat, once a catalyst forces them to close their positions (such as an adverse price movement), there will be a lack of counterparties in the market to absorb these closing orders. This will trigger a stampede-like "escape from the exit," leading to extreme, violent, one-way price movements. For crowded short positions, this stampede manifests as a devastating short squeeze. This hedging tool, originally intended for risk management, has, due to its collective use, instead created a new and greater source of systemic risk. 2.3 Identifying Imbalances: Detecting Crowds through Data Analysis While individual traders cannot know exactly how many others hold the same position as them, analyzing public market data can effectively identify signs of crowded trading. Open Interest (OI) Analysis: OI is a key metric measuring the total number of open derivatives contracts in the market, reflecting the total amount of capital flowing into the market and market participation. In the pre-market, if OI rises continuously and rapidly while prices stagnate or even decline slightly, it is a strong signal that a large amount of capital is pouring into short positions, forming a bearish consensus and a crowded short market. On-chain Data Analysis: Although the tokens are not yet in circulation, analysts can track airdrop-related activity using blockchain explorers. By analyzing the number of wallets eligible for the airdrop, the concentration of token distribution, and the historical behavior of these wallets, we can roughly estimate the total amount of "spot" positions that may require hedging. A large and dispersed airdrop often indicates stronger hedging demand and increased congestion risk. Funding Rates and Spreads: On platforms like Hyperliquid that have funding rates, persistently negative and deepening funding rates are direct evidence of short-selling dominance. On platforms like Aevo, despite the lack of funding rates, the widening bid-ask spread and order book depth on the sell side, significantly greater than on the buy side, also reflect unilateral selling pressure. This series of analyses reveals a profound phenomenon: "crowded hedging" in the pre-market isn't an accident of market failure, but rather an inevitable product of system design. The airdrop mechanism creates a large, well-motivated group, and the pre-market market provides them with a perfect hedging tool. Rational behavior at the individual level (hedging risk) converges into an irrational state at the collective level (an extremely vulnerable, crowded position). This vulnerability is predictable, systematically concentrating a large number of traders seeking safe havens, creating a perfect prey pool for predators who understand and are able to exploit this structural flaw. A short squeeze or long squeeze doesn't require a rationale, narrative, or purpose. Instead, when funds reach a certain level, they attract whales and gamblers—the contract version of a hidden gem. Section 3: Ignition Momentum: Exploiting Crowded Trades and Triggering Cascading Liquidations 3.1 Momentum Ignition: The Mechanism of a Predatory Trading Strategy Momentum ignition is a complex market manipulation strategy typically executed by high-frequency traders or large trading funds. Its core objective isn't based on fundamental analysis. Instead, it's to artificially create unidirectional price momentum through a series of rapid, aggressive trades, aiming to trigger pre-set stop-loss orders or forced liquidation levels in the market, and then profit from the resulting chain reaction. The strategy typically follows a precise "attack sequence": Probing and Preparing: The attacker first tests the market's liquidity depth by submitting a series of small, rapid orders, creating the illusion of growing demand. Aggressive Order Placing: After confirming insufficient market depth, the attacker floods the order book with a large number of market buy orders in a very short period of time. The goal of this phase is to quickly and violently drive prices up. Triggering a Chain Reaction: The sharp price increase hits the forced liquidation price for a large number of crowded short positions. Once the first liquidation is triggered, the exchange's risk engine automatically executes a market buy order to close the short position, further driving up the price. Profit-Taking: The initial attacker had already built up a large long position during the first and second phases. When the cascading liquidations began and a large amount of passive buying flooded the market, the attacker began to reverse course, selling their long positions to these forced liquidators, thereby profiting from the inflated prices they had created. 3.2 Perfect Prey: How Illiquidity and Crowded Shorts Create the Ideal Attack Environment The pre-market market provides a near-perfect breeding ground for the implementation of momentum ignition strategies. Extremely Low Liquidity: As mentioned earlier, liquidity in the pre-market is extremely scarce. This means attackers only need relatively little capital to significantly impact prices. Manipulative actions that would be costly in mature, liquid markets become inexpensive and efficient in the pre-market. Predictable Liquidation Clusters: Because a large number of hedgers use similar entry prices and leverage, their forced liquidation prices are densely distributed within a narrow range above the market price. This creates a clear, predictable "liquidation cluster." The attacker knows they only need to push the price up to this area to trigger a chain reaction. This is consistent with the logic of "stop-loss hunting" in traditional markets, where attackers specifically target known areas of concentrated stop-loss orders. (Using a liquidation map) One-sided market structure: Crowded shorts mean that during price increases, there is little natural buying power to absorb the attacker's selling pressure. Prices can rise effortlessly until they hit the "wall" of the liquidation cluster. Once the market hits, passive liquidation buying becomes the fuel that propels prices higher. 3.3 Disintegration: From Targeted Elimination to Comprehensive Cascading Liquidations The entire process is a carefully orchestrated, staged disintegration. Short Squeeze: The initial price surge triggered by a momentum ignition strategy first triggers the liquidation of the most leveraged and vulnerable short positions. The buying generated by these forced liquidations further drives prices higher, creating a classic short squeeze. Cascading Liquidations: The price, driven higher by the first round of short squeezes, now reaches the liquidation level for the second and third tranches of short positions. This creates a vicious positive feedback loop: liquidations lead to higher prices, which in turn trigger more liquidations. The market spirals out of control, with prices rising vertically in a very short period of time, forming the long upper shadows often seen on charts, known as "liar candlesticks." The ultimate outcome: For early holders seeking to hedge, they suffer a "margin call"—their margins are depleted, their hedged positions are forcibly liquidated, and they suffer significant financial losses. Not only do they lose the "insurance" they established to protect the spot value, but they also pay a heavy price for it. When the chain liquidation exhausts all available short positions and the attackers reap their profits, prices often quickly fall back to their initial levels, leaving behind a devastating situation. A deeper analysis reveals that momentum ignition strategies in the pre-market go beyond simple market manipulation, or rather, are not market manipulation at all; they are more like a game of capital. It is a form of structural arbitrage exploiting flaws in the market's microstructure. The attacker exploited publicly available information (the size of the airdrop), the platform's design (leverage), and predictable group behavior (collective hedging). By calculating the cost of the attack (the funds required to drive up prices in a low-liquidity market) and the potential payoff (profits after triggering a liquidation cluster), they executed a near-deterministic gamble. Their profits came not from a correct assessment of asset value, but from the precise exploitation and amplification of market failures.

Know the facts, and understand the reasons behind them

May we always maintain a reverent respect for the market.