How to Avoid the Reoccurrence of the 1011 Intra-Market Stampede? Construction and Algorithm Design of Circuit Breaker Mechanisms Under Low Liquidity

This article begins with the sharp drop of USDe on CEX to $0.65, while the on-chain price remains at $0.99, analyzing the local liquidation cascade risks caused by liquidity isolation in the crypto market, and revealing the destructive power of indiscriminate liquidation by liquidation robots and the bottlenecks in deposit and withdrawal channels in a liquidity vacuum.

This article proposes a circuit breaker mechanism algorithm based on composite quantitative indicators, using price deviation, order depth, and large-scale liquidation exposure as triggering reference conditions. The circuit breaker mechanism aims to provide the market with an n-minute adjustment window, allowing market makers to overcome operational frictions such as large withdrawals/deposits and on-chain congestion, injecting external liquidity. Ultimately, through an orderly collective auction to restart trading, it prevents a vicious cycle of liquidation, ensures market structure stability, and alleviates and reduces the misfortune of positions that do not need to be liquidated.

I. The Fragmented Structure of Liquidity in the Crypto Market

1.1. Liquidity Map of the Crypto Market: CeFi, DeFi, and Cross-Chain Isolation

The unique liquidity structure of the crypto asset market is the root of its inherent risks. Liquidity is highly fragmented, spanning CEX, DEX, and various DeFi platforms. This liquidity isolation forms a fragmented ecosystem, where friction between different liquidity pools (such as high on-chain transaction fees, complex cross-chain bridging times, and CEX's review or locking mechanisms for large deposits and withdrawals) greatly hinders the free and rapid flow of capital. This structural friction is a significant reason why local liquidity crises can quickly worsen and cannot be timely repaired by arbitrage activities.

1.2. Market Maker Behavior and Risk Spillover in Extreme Market Events

During severe market fluctuations, liquidity providers (Market Makers) quickly withdraw limit orders, leading to an expansion of the bid-ask spread and a sharp depletion of order book depth.

When a liquidation cascade occurs, the liquidation engine and liquidation robots will trigger forced liquidations. These forced liquidations often manifest as large market orders, indiscriminately selling on a thin order book, further driving down prices. The failure of this market mechanism causes the price discovery process to detach from fundamentals, entering a self-reinforcing liquidation feedback loop.

1.3. Positioning of the Circuit Breaker Mechanism: From Passive Suspension to Active Liquidity Management

The core value of the circuit breaker mechanism lies in providing an event window for active risk isolation and liquidity redistribution during a liquidity vacuum in the market. The essence of the circuit breaker is to temporarily halt trading activities to prevent flash crashes driven by automated trading systems and panic from worsening in a liquidity vacuum.

The circuit breaker mechanism triggers through precise algorithms, quickly isolating risks and establishing a set of operational protocols to ensure that external capital can flow back into the market quickly and smoothly, thereby rebuilding liquidity depth when trading resumes.

II. The USDe Incident on October 11, 2025: An Analysis of Local Liquidity Failure on CEX

2.1 Price Discrepancy of USDe on CEX and DEX: Chain Reactions Caused by Local Failures

From October 10 to 11, 2025, the crypto market experienced the largest deleveraging event in history, with over $19 billion in leveraged positions liquidated in less than 24 hours. The destructive power of this severe market correction primarily stemmed from high leverage in the market and the failure of exchange risk mitigation mechanisms.

According to public data, the sequence of market declines is as follows:

20:50 UTC, Oct 10: External shocks (such as tariff threats) trigger market turmoil, thinning liquidity.
21:20 – 21:21 UTC, Oct 10: BTC and ETH prices drop to intraday lows, systemic selling peaks.
21:20 – 21:42 UTC, Oct 10: Ethena's USDe begins to fall below $1 on the Binance spot market.
After 21:36 UTC: A severe decoupling event occurs, and the liquidation cascade begins to intensify.
21:42 – 21:51 UTC, Oct 10: USDe price drops to a low of $0.65 on Binance, while other assets like wBETH and BNSOL also show significant price discrepancies with ETH and SOL.

Severe Disconnection in Cross-Platform Price Discovery

On the Binance spot market, USDe briefly fell to $0.65, while Bybit also dropped to $0.92. However, during the same period, in on-chain liquidity pools, such as those on Curve, the price of USDe remained around $0.99. Additionally, the minting and redemption functions of the Ethena protocol continued to operate normally.

This significant price discrepancy (nearly 35%) between CEX and DEX reveals the essence of the problem: it is not a fundamental decoupling of the USDe asset itself, but rather a local failure of the internal pricing mechanism on CEX. When the liquidation cascade begins, order book liquidity is rapidly withdrawn. Exchanges like Binance rely on their internal spot market prices to estimate the value of collateral. When the internal spot market lacks depth, even a small trading shock can lead to severe price distortions, causing the liquidation engine to incorrectly assess the value of USDe (and other pegged assets like wBETH) as collateral. This mispricing leads to unnecessary forced liquidations, and the liquidation engine's "adding fuel to the fire" behavior further drives the price down to $0.65.

2.2 What Hinders Liquidity: Time, Network, and Operational Barriers

During extreme volatility, arbitrage activities face multiple "channel bottlenecks," preventing liquidity from being timely moved back into the market.

Settlement time and network congestion: During extreme market activity, blockchain networks typically experience high transaction volumes, leading to network congestion. This extends transaction confirmation times and causes gas fees to soar.

CEX operational locks: CEX's restrictions and reviews on large deposits and withdrawals prevent market makers from injecting this external liquidity into the market within the required minute-level response window.

The circuit breaker mechanism is designed to provide a sufficiently long time window in extreme market environments to address these technical, operational, and risk control barriers—providing a breathing space for liquidity.

It is akin to inserting a temporary catheter into a patient with a pneumothorax (liquidity vacuum) to clear excess air (liquidation energy), allowing the patient to survive.

III. Design of the Circuit Breaker Trigger Algorithm: Composite Quantitative Indicators

To address the unique high-frequency and decentralized characteristics of the crypto market, the circuit breaker trigger mechanism must go beyond the single index drop threshold found in traditional finance. A single, linear price trigger mechanism is easily predictable and manipulable by high-frequency traders, leading to a "magnet effect" near the threshold, where traders accelerate trading to avoid being halted, thereby exacerbating market volatility before the trigger.

This article proposes a circuit breaker algorithm based on composite quantitative indicators, which includes three core dimensions: price deviation, liquidity shock, and trading speed. The system will only activate the circuit breaker alarm when all three indicators simultaneously or within a very short time frame trigger preset thresholds.

3.1. Indicator 1: Cross-Platform Reference Price Deviation (CVD) and Its Index Construction

Introduce a multi-source weighted aggregate price index based on multiple high-liquidity sources as a reference price to resist failures in the internal pricing of a single CEX.

CVD = |PriceCEX - PriceIndex| / Price_Index * 100%

The first condition for triggering the circuit breaker is the emergence of an unsustainable deviation between the on-site spot price and the reference price index:

Quantitative threshold: Considering that pegged assets like USDe should normally be tightly anchored (0.1% deviation), when the price difference exceeds the range explained by arbitrage costs, trading delays, and on-chain liquidity pools, a circuit breaker alarm should be issued.
Suggested threshold: Set cross-platform reference price deviation CVD > 3%.
Empirical significance: In the October 11 incident, when USDe fell below $0.97 on Binance, the circuit breaker alarm was triggered, well before it dropped to the low of $0.65, effectively isolating risks.

3.2. Indicator 2: Order Book Depth and Liquidity Shock (DOM/Slippage Shock)

Price changes are the result; liquidity depletion is the cause of structural failure. Therefore, the circuit breaker mechanism must directly monitor the health of the order book.

Order book depth ratio RL: Measures the cumulative tradable quantity QCurrent within a specific price range (e.g., deviation from the current price delta = 1%) against the asset's median depth during calm periods (e.g., the past 30 days) Q_Benchmark.

RL = QCurrent / Q_Benchmark

Trigger threshold: R_L 20%, meaning the order book depth has depleted more than 80% compared to normal levels.

Slippage impact S_I: This is a more intuitive indicator of liquidity vacuum. It is defined as the expected percentage price slippage caused by executing a market order of a preset nominal value V (e.g., V=$1M USD).

SI = (PExecuted - PMid) / PMid * 100%

Where PMid is the TWAP transaction price, and PExecuted is the final price after executing the V order. In times of ample liquidity, SI is very low; when the order book is drained, SI will increase sharply.

Trigger threshold: Set S_I > 5%, indicating that executing medium-sized trades will immediately result in severe slippage, reflecting that liquidity is in a vacuum state.

3.3. Indicator 3: Trading Speed and Liquidation Risk Exposure

In addition to the structural indicators mentioned above, the circuit breaker mechanism should also include an indicator for large-scale liquidation exposure.

Price speed V_P: Monitors the rapid change rate of asset prices within a very short time window (e.g., 5 minutes).

Trigger threshold: Similar to the circuit breaker design in securities markets, for example, V_P > 10% drop.
Liquidation risk exposure (LCE): Combines price speed V_P with open interest (OI) data to estimate the distance to the next large-scale liquidation cluster. When LCE exceeds a preset critical value, indicating that the market is on the brink of a liquidation cascade, the circuit breaker should be triggered to prevent system collapse, even if price deviation and depth depletion have not yet reached extreme levels.

Circuit breaker trigger conditions:

The circuit breaker will only be triggered when both the cross-platform reference price deviation and order book depth ratio simultaneously meet warning conditions, or when price speed, slippage impact, and liquidation risk exposure all reach their thresholds.

IV. Operations During the Circuit Breaker Phase: Liquidity Injection and Risk Isolation

Once the circuit breaker algorithm is triggered, the market enters a pause state for N minutes. The success of this phase entirely depends on whether exchanges and market makers can eliminate the channel bottlenecks for liquidity replenishment and implement risk control measures during this time.

4.1. Dynamic Calibration Model for Circuit Breaker Window N

The setting of the circuit breaker window N must meet the need to overcome the longest and most critical liquidity transfer frictions.

N = max (TDLP, TOn-chainPriority) + TBuffer

Where:

Tl_DLP: The longest time required for market makers to transfer funds from their own off-chain liquidity pools to internal accounts on CEX (which may involve cross-CEX or fiat withdrawal lock processes).

TOn-chainPriority: The fastest confirmation time required for on-chain transfers (e.g., transferring stablecoins from DEX to CEX addresses) achieved by paying high-priority gas fees during congestion.

T_Buffer: Additional buffer time for information digestion and recalibration of the market maker's risk control system.

The circuit breaker mechanism must rely on two emergency funding channels:

Pre-custodied external cold wallet funds: The circuit breaker N must cover the time it takes for CEX to transfer funds from cold wallets to hot wallets and allocate them to market maker accounts.
High-speed, high-priority on-chain transfers: The circuit breaker N must cover the rapid confirmation time under extremely high gas fees (usually from a few minutes to over ten minutes).
Actual calibration: Considering that emergency funding requires manual intervention and decision-making time from the market maker team, as well as network congestion and internal processing queues, it is recommended to set N in the range of 5 to 10 minutes to ensure that market makers have a reasonable time window to execute their emergency funding processes.

4.2. Priority Funding Agreement for Designated Liquidity Providers (DLP)

During the circuit breaker, the exchange must initiate an Out-of-Band Capital Protocol (OBCP) specifically for designated liquidity providers (DLPs).

DLP certification and qualification: The exchange must pre-screen and certify institutions with sufficient off-chain emergency liquidity as DLPs.
OBCP channel: Establish dedicated, high-priority API interfaces or internal clearing processes that allow DLPs to submit large stablecoin deposits during the circuit breaker. These deposits must be immediately credited to the DLP's internal trading account, bypassing the withdrawal locks, queues, and review processes faced by standard users.
Pre-submission of orders during the circuit breaker: All market orders are canceled during the trading pause of the circuit breaker. However, DLPs and other authorized participants are allowed to submit new limit orders. These orders will not be executed during the pause but will serve as a willingness and basis for liquidity return, entering the order book when trading resumes. This ensures that when the market restarts, the order book can immediately restore depth, avoiding price gaps.

4.3. Risk Isolation and Liquidation Suspension Mechanism

After the circuit breaker is triggered, the following risk isolation measures must be immediately implemented:

Comprehensive suspension of liquidation: All margin calls and forced liquidation operations by the liquidation engine must be immediately halted. The fundamental goal of the circuit breaker is to prevent the self-reinforcing cycle of liquidation cascades.

Collateral value lock: During the pause, the collateral price used to calculate margin positions (e.g., USDe during the October 11 incident) must be locked at the last valid reference price before the circuit breaker was triggered. This can prevent the collateral value from further plummeting due to failures in market microstructure, thereby protecting users from unnecessary liquidation risks.

V. Trading Recovery Mechanism: Quantitative Safety Standards and Orderly Restart

The end of the circuit breaker should not depend on a predetermined time but rather on whether liquidity has returned to normal levels. If the market is recklessly restarted while liquidity has not yet recovered, it may lead to larger price gaps and secondary panic.

5.1. Quantitative Prerequisites for Resuming Trading

The prerequisites for lifting the circuit breaker are that the order book depth and cross-platform price discovery mechanisms must return to healthy levels. The system must continuously monitor the following indicators after the N-minute circuit breaker window ends until they meet recovery standards:

a. Convergence of price spreads (CVD): The cross-platform price spread must converge to a level close to the arbitrage limit.

Recovery standard 1: CVD 1%. This indicates that the on-site price is highly aligned with the external reference index, and the issue of local pricing distortion has been resolved.

b. Depth recovery (R_L): The order book depth must be sufficient to absorb large-scale trades, preventing immediate slippage upon recovery.

Recovery standard 2: R_L > 50%. This means that the cumulative depth of the order book within a ±1% range must recover to at least half of the median level during normal periods. Below this threshold, resuming trading will face significant execution risks.

c. Reduction of liquidation risk: Assess whether the liquidation risk exposure (LCE) has been reduced to a safe level, indicating that leverage has been effectively deleveraged.

5.2. Phased Orderly Restart Process: Cool-down Period and Auction

To prevent chaos and price gaps during the resumption of trading, the exchange should adopt an orderly, phased restart mechanism, similar to the auction process in traditional financial markets.

Phase I: Cool-down Period

Duration: 2-5 minutes.

Action: Cancel all remaining market orders. Allow market participants, especially market makers, to submit new limit orders or modify limit orders submitted before the pause. Market information (e.g., total depth of unfilled orders and the latest reference price) should be widely disseminated, but orders will not be executed.

Phase II: Auction Period

Duration: 2-5 minutes.

Action: The system collects all orders submitted during the cool-down and circuit breaker periods. Using a balanced price discovery algorithm, it calculates a single equilibrium price that maximizes trading volume during this auction period. All orders executed at the optimal price will be matched at this equilibrium price. The auction ensures transparency in price discovery and utilizes the liquidity injected by DLPs during the pause to establish a stable initial price.

Phase III: Continuous Trading

Action: Resume normal trading. All remaining limit orders (those not executed in the auction) enter the order book, and the market returns to continuous matching mode.

Just like a craniotomy, suturing the opening is only a temporary end; there will be subsequent rehabilitation, checks, and rest.

VI. Some Ramblings

The circuit breaker mechanism actively compensates for the systemic vulnerabilities in the crypto market caused by liquidity isolation and operational frictions during extreme volatility by introducing a time isolation window (N minutes). The USDe incident on October 11, 2025, clearly demonstrates that when liquidation cascades overlap with an on-site liquidity vacuum, even assets with sound on-chain redemption mechanisms can lead to catastrophic consequences due to local mispricing on CEX.

The core design of this mechanism includes:

Composite trigger algorithm: Avoiding the "magnet effect" caused by a single price trigger, using composite indicators of price deviation, order book depth, and slippage impact to accurately capture the collapse of market microstructure.
Dynamic circuit breaker duration: The setting of N must aim to overcome the "channel bottlenecks" for market maker funding, particularly addressing operational/technical barriers such as CEX deposit and withdrawal restrictions, risk control strategy optimization, and on-chain network congestion.
Orderly recovery protocol: Introducing a cool-down period and auction, with quantitative indicators of liquidity return as necessary conditions for resuming trading, ensuring that the market restart is stable and deep.

As the DeFi ecosystem matures, systemic risks from cross-chain and decentralized protocols are also increasing. The concept of a circuit breaker can be extended to the DeFi space, for example:

In automated market maker (AMM) pools, when depth sharply declines, causing the expected slippage for executing trades of a specific size to exceed a critical threshold, a protocol-level trading pause can be triggered.

The circuit breaker mechanism is not a panacea; at best, it is a pulse defibrillation, a shot of adrenaline, a temporary intubation, just to buy you time to reach the emergency room.

Postscript

The cover image is of Singapore's former Prime Minister Lee Hsien Loong announcing the home isolation policy during the COVID period in 2020, also known as the "Circuit Breaker" (cb).

It is somewhat ironic that we use cb to block the spread of the virus and also use cb to ensure sufficient liquidity in the market.

Throughout the text, I refer to "insufficient liquidity" as a "disease"; many ailments do not actually take away positions, but it is a pity that one cannot hold on until the moment of a blood transfusion.

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