Does South Korea's ban on market making cause price distortion? The liquidity dilemma under global regulatory differences

Source: DigitalToday Original Title: Frequent Enclosure Pumping…“Only Korea Blocks ‘Market Making,’ Exacerbating Price Distortion” Original Link:

Market Structure Issues Emerge

After a major exchange was hacked, domestic token prices in Korea diverged significantly from overseas markets, repeatedly triggering the “enclosure pumping” phenomenon. This situation is driving calls within the virtual asset market to establish a legal market-making mechanism.

According to statistical data, several cases of price divergence occurred in the domestic virtual asset market over the past week. Certain project tokens traded at prices over 10% higher domestically than abroad, while some ecosystem coins experienced sharp fluctuations of up to 20% domestically. During periods when deposits and withdrawals were suspended at a leading exchange, specific tokens experienced short-term price distortions of 7-12%.

During a major exchange hack at the end of last month, prices of ecosystem tokens fluctuated by as much as 72%. With deposits and withdrawals blocked and insufficient order book depth, a surge of buy orders pushed prices up, resulting in “enclosure pumping.” Similar cases have persisted domestically over the past year. In April, regulators received reports of “racehorse·enclosure pumping” organizations manipulating prices by exploiting multiple accounts and price differences between exchanges. At the time, price fluctuations for some virtual assets on specific exchanges exceeded ten times those on others.

The Root Cause: Lack of Market-Making Mechanism

While the direct causes of each incident differ, a common vulnerability lies in the absence of a liquidity-providing mechanism in the domestic market.

Since late 2023, regulators have stated that “market-making activities in the virtual asset market may constitute price manipulation and could be subject to criminal penalties or fines.” Unlike the Capital Markets Act, last year’s Virtual Asset User Protection Act did not include exceptions recognizing legitimate market-making activities. This means market-making could be interpreted as price manipulation.

As a result, whenever exchange failures, deposit/withdrawal suspensions, or trade warnings occur, there are no institutional market makers to absorb price shocks. This is especially problematic for illiquid altcoins, where large order book gaps lead to repeated price distortions like enclosure pumping.

Industry research institutions reported earlier this year that “it is urgent to introduce a market maker system in the domestic virtual asset market,” noting that “regulatory ambiguity causes legitimate market-making activities to be misunderstood as price manipulation, increasing market volatility and diminishing the global competitiveness of domestic exchanges.”

Global Regulatory Differences

Some argue that Korea’s virtual asset market has become an easily manipulated “enclosure farm” due to the lack of legal market makers.

In traditional capital markets, market makers cushion buy-sell spreads, but the absence of legal market makers in the Korean virtual asset market makes it more vulnerable to price distortions.

There are clear differences in international regulation. The US, EU, Singapore, Japan, and other major countries allow market makers who meet certain conditions to provide liquidity and stabilize prices by narrowing spreads. Unlike Korea, market makers in these countries continually fill order books, making large price deviations less likely.

An overseas institutional representative commented, “Korea’s lack of institutional market makers results in shallow liquidity and an isolated market,” adding, “Even with workarounds like order book sharing or mirroring, the market structure remains vulnerable to price manipulation.” This explains why Korea’s market is nicknamed a “fish tank” internationally.

Essential Infrastructure Before Opening the Institutional Market

Market making should be permitted before opening the institutional investor market. In institutional markets, there are various types of market makers—brokers, dealers, liquidity providers—who support price stability and continuous trading. If such an ecosystem is not established before opening the market, concerns about volatility may result in insufficient institutional investor participation.

Legal professionals state, “Market making plays a neutral role in narrowing spreads and providing liquidity,” and advocate that it “should be treated as basic infrastructure within an appropriate regulatory framework.”