Hyperliquid sets Jelly trades renewing code is law debate

A trader on the Hyperliquid decentralised exchange has been implicated in an alleged market manipulation scheme involving the small cap JELLY token. The scheme sparked a short squeeze which resulted in the decentralised exchange taking action to close out positions, and possibly showing centralisation of the exchange, and renewing debates over whether code is law and decentralisation in crypto markets.

The trader in question held US $4.85 million worth of JELLY, combining a short position on HyperLiquid with on-chain spot buys. The combination of these actions led to a liquidation of the short position, which the market-making arm of HyperLiquid, called Hyperliquidity Provider (HLP) inherited. The trader then aggressively bought JELLY on other decentralised exchanges, pushing up the price on these exchanges and temporarily causing HLP's unrealised losses to skyrocket.

Binance, the world’s largest cryptocurrency exchange by trading volume, then announced it was listing futures tied to JELLY, causing spot prices to skyrocket by 560%. Other exchanges followed with new listings. The move likely deepened the short squeeze affecting the JELLY token.

In an attempt to minimize losses, the HyperLiquid exchange force-closed the JELLY market following a governance vote by validators, settling the position at $0.0095 instead of the $0.50 market price fed by decentralized exchanges.

HyperLiquid wrote on X explaning the decision to close the market,

After evidence of suspicious market activity, the validator set convened and voted to delist JELLY perps,

All users, apart from flagged addresses, will be made whole from the Hyper Foundation. This will be done automatically in the coming days based on on-chain data.

HyperLiquid's actions sparked outrage in some quarters on social media. The trader who manipulated the JELLY market ended up with a small loss.

This incident draws parallels to an exploit on Mango Markets in 2022, where a trader named Avraham Eisenberg manipulated oracle prices to secure gains on derivative markets. Both incidents sparked controversy renewing the code is law debate, that is the question of whether trading activities which are possible via smart contracts are therefore legally permissible. In the Mango Markets case, Eisenberg was eventually prosecuted and convicted on commodities fraud and market manipulation charges. The forced close out of JELLY contracts at a favourable price and bail out by Hyper Foundation also raised concerns over the ability of the validator group to effectively intervene in a decentralised market to override the Hyperliquid automated market maker.

Similar to the Mango Markets incident, this incident highlights the vulnerability of decentralised exchanges to market manipulation involving illiquid tokens. As regulators around the world increasingly scrutinise crypto-asset markets, market misconduct including insider trading and market manipulation are likely to come under increasing scrutiny.

Written by Jake Huang and Steven Pettigrove with Michael Bacina