Author: YQ

Translation: AididiaoJP, Foresight News

In the previous three analyses regarding the cryptocurrency liquidation chain reaction from October 10 to 11, I examined oracle failures, infrastructure collapses, and potential coordinated attack vectors. This article will turn to perhaps the most critical yet underappreciated aspect: market makers. How these entities, which are supposed to provide market stability, became the main catalyst for creating an unprecedented liquidity vacuum, transforming a controllable adjustment into a $19 billion disaster.

Understanding Market Makers: Theory and Reality

Before examining the crash in October, it is crucial to understand what market makers are supposed to do. In traditional financial markets, market makers are intermediary entities that continuously quote buy and sell prices for financial instruments. They profit from the spread between these prices while providing a key service: liquidity.

The theoretical roles of market makers include:

• Continuous price discovery: Maintaining two-way quotes that reflect fair market value
• Liquidity provision: Ensuring traders can buy and sell at any time without significant price impact
• Volatility suppression: Absorbing temporary supply and demand imbalances
• Market efficiency: Arbitraging between different venues to maintain uniform pricing

In the cryptocurrency market, market makers operate similarly but face unique challenges:

• 24/7 continuous markets with no closing bell
• Liquidity dispersed across hundreds of exchanges
• Extreme volatility compared to traditional assets
• Limited regulatory oversight and obligations
• Technical infrastructure requirements for high-frequency trading

Under normal market conditions, this system works quite well. Market makers earn moderate spreads while providing necessary liquidity. However, the events of October 10 to 11 revealed what happens when arbitrage and responsibility diverge.

Withdrawal Timeline

The precision of market makers' withdrawals during the October crash revealed coordinated behavior rather than panic. Here are the details of how liquidity evaporated:

20:00 UTC: News of Trump officially announcing a 100% tariff on Chinese imports hits social media. Bitcoin drops from $122,000. Market makers maintain their positions but begin to widen spreads, which is a standard defensive behavior.

_Chart description: Binance's unnamed token _0's bid-ask depth chart over the past 24 hours. Buy orders are below the X-axis, and sell orders are above. From Coinwatch_

20:40 UTC: Real-time tracking data shows the beginning of catastrophic liquidity withdrawals. Market depth for a major token begins to plummet from $1.2 million.

21:00 UTC: A critical turning point. As the U.S. trading session begins, macro conditions deteriorate sharply. Institutional participants withdraw liquidity, spreads widen, and order book depth thins. At this point, market makers shift from a defensive posture to a complete withdrawal.

21:20 UTC: Peak chaos. Almost all tokens hit bottom during the global liquidation wave. The market depth for tracked tokens has dropped to just $27,000, a 98% plunge. At the $108,000 price level, liquidity providers stop maintaining prices, and some altcoins are pushed down by 80%.

21:35 UTC: As the most intense sell-off exhausts, market makers cautiously begin to return. Within 35 minutes, the aggregated buy and sell order depth on centralized exchanges recovers to over 90% of pre-event levels, but only after causing the maximum damage.

This pattern reveals three key points:

• Market makers had a 20-40 minute warning before fully withdrawing
• Withdrawal behavior was synchronized across multiple firms
• Liquidity only returned after profitable re-entry points emerged

When Insurance Funds Fail: Automatic Liquidation Chain Reaction

When market makers abandon price maintenance and liquidation overwhelms the order book, exchanges initiate their last line of defense: automatic liquidation. Understanding this mechanism is crucial to grasping the full picture of the October disaster.

How Automatic Liquidation Works on Centralized Exchanges

Automatic liquidation represents the third and final level in the liquidation hierarchy:

• Level 1 Order Book Liquidation: When a position falls below the maintenance margin, the exchange attempts to close it through the order book. If successful at a price better than the bankruptcy price (i.e., the price when margin = 0), excess funds flow into the insurance fund.
• Level 2 Insurance Fund: If order book liquidity is insufficient, the insurance fund absorbs the losses. This fund is built up from liquidation profits during normal times and acts as a buffer for bad debts.
• Level 3 Automatic Liquidation: When the insurance fund cannot cover the losses, the exchange forcibly closes the profitable positions of counterparties.

Automatic Liquidation ADL Ranking System

Binance's automatic liquidation mechanism uses a complex ranking formula:

Automatic liquidation ranking score = Position P&L percentage × Effective leverage

Where:

• Position P&L percentage = Unrealized profit / abs(Position nominal value)
• Effective leverage = abs(Position nominal value) / (Account balance - Unrealized losses + Unrealized profits)

Bybit's approach is similar but includes additional safeguards. They display a 5-tier ranking, showing percentile rankings:

• Level 5 = Top 20% (highest priority for automatic liquidation)
• Level 4 = 20-40%
• Level 3 = 40-60%
• Level 2 = 60-80%
• Level 1 = Bottom 20% (lowest priority for automatic liquidation)

The cruel irony is that the most successful traders, those with the highest profits and leverage, are the first to be forcibly liquidated.

October's Automatic Liquidation Disaster

The scale of automatic liquidations from October 10 to 11 was unprecedented:

• Hyperliquid: Full-margin automatic liquidation activated for the first time in over two years, affecting over 1,000 wallets
• Binance: Widespread automatic liquidations were triggered
• Bybit: Reported over 50,000 short positions liquidated, totaling $1.1 billion
• BitMEX: Due to a large insurance fund, only 15 contracts were automatically liquidated

The correlation with market makers' withdrawal timing is undeniable. As the order book was cleared between 21:00-21:20 UTC, liquidations could not be completed normally, forcing the insurance fund to deplete rapidly and activate automatic liquidations.

Case Study: Chain Reaction Example

Consider what happened to a typical hedged portfolio during that critical 35 minutes:

21:00 UTC: Trader holds

• Bitcoin long: $5 million, 3x leverage
• Dogecoin short: $500,000, 15x leverage (profitable hedged position)
• Ethereum long: $1 million, 5x leverage

21:10 UTC: Market makers withdraw. Dogecoin plummets, and the short position becomes highly profitable. However, this triggers automatic liquidation due to the high leverage + profitable combination.

21:15 UTC: The Dogecoin short is forcibly closed through automatic liquidation, and the portfolio now loses its hedge.

21:20 UTC: Without a hedge, the Bitcoin and Ethereum long positions are liquidated in the chain reaction.

Total loss: Entire portfolio.

This pattern repeated thousands of times. Mature traders holding carefully balanced positions saw their profitable hedged positions forcibly liquidated through automatic liquidation, leaving them with unhedged risk exposure, which was subsequently liquidated.

Reasons for Market Maker Failures: Incentive Issues

The synchronized withdrawal of liquidity revealed a fundamental structural problem. Market makers face incentives across multiple markets:

Asymmetric Risk/Reward

During extreme volatility, the potential losses from maintaining quotes far exceed the spread profits. A market maker quoting $1 million in depth may earn $10,000 in spread during normal times but could face a $500,000 loss during a chain reaction.

Information Advantage

Market makers can see aggregated order flow and position distribution. When they detect a massive long bias (87% of positions are long), they know which direction the chain reaction will take. Why provide buy orders when you know a tsunami of sell orders is about to hit?

Lack of Obligations

Unlike designated market makers in traditional exchanges with regulatory requirements, cryptocurrency market makers can withdraw at will, abandoning their posts during a crisis without penalty.

Arbitrage Opportunities

Data from the crash shows that market makers withdrawing quotes shifted to arbitraging between different exchanges. As price differences between venues exceeded $300, arbitrage became far more profitable than making markets.

Destructive Feedback Loop

The interaction between market maker withdrawals and automatic liquidations created a destructive feedback loop:

1. Initial shock (Trump tariff announcement) triggers sell-off
2. Market makers sense the possibility of a chain reaction and withdraw
3. Liquidation cannot be completed through the empty order book
4. The insurance fund rapidly depletes to absorb bad debts
5. Automatic liquidation activates, forcibly closing profitable positions
6. Liquidated traders must re-hedge, increasing sell pressure
7. More liquidations trigger, returning to step 3

This loop continues until leveraged positions essentially disappear. Data shows that the total open interest in the market dropped by about 50% within hours.

Disturbing Truths About Market Structure

The disaster from October 10 to 11 was primarily not about over-leverage or regulatory failure, but about misaligned incentives within market structure. When those responsible for maintaining orderly markets profit more from chaos than from stability, chaos becomes inevitable.

Timeline data reveals that market makers did not panic; they executed coordinated withdrawals at the optimal moment to minimize their losses while maximizing subsequent opportunities. This rational behavior under the current incentive structure produced irrational results for the entire market.

Rebuilding Trust Through Accountability

The liquidity crisis in October 2025 exposed a critical weakness in the cryptocurrency market: voluntary liquidity provision fails precisely when involuntary provision is most needed. The $19 billion in liquidations was not just about over-leveraged traders being trapped; it was a predictable outcome of a system where market makers enjoy all the privileges of liquidity provision without any responsibility.

Pure laissez-faire market making does not work under pressure. Just as traditional markets evolved from the chaos of unregulated trading to include circuit breakers, position limits, and market maker obligations, the cryptocurrency market must implement similar safeguards.

Technical solutions exist:

• A tiered obligation system that ties incentives to responsibilities
• Insurance funds sized based on actual risk rather than optimistic forecasts
• Automatic liquidation mechanisms with circuit breakers to prevent chain reactions
• Real-time transparency of market maker behavior

What is lacking is the willingness to implement them. Unless cryptocurrency exchanges prioritize long-term stability over short-term profit maximization, we will continue to experience these "unprecedented" events with frustrating regularity.

The 1.6 million accounts liquidated from October 10 to 11 paid the price for this structural failure. The question is whether the industry will learn from their sacrifice or simply wait for the next batch of traders to discover that when a crisis hits, the market makers they rely on will vanish like smoke, leaving behind chain liquidations and forcibly closed profitable positions.

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