While everyone was preoccupied with bitcoin price drops after last Friday's 'fake Chinese bitcoin ban' news incident, something even more dramatic was happening at China's largest exchange, Huobi, and its new litecoin trading system.

A 'flash crash' on the exchange saw the price plunge to just 1 RMB (Chinese yuan) a short time after a hoax news report of a complete government ban on digital currencies was posted on microblogging site Sina Weibo and reported by Sina's financial news service.

The number of trades executed at that price is unknown, as is the total amount of money lost – either by the company or by traders who lost due to margin calls. However, soon after the incident, Huobi agreed to make its customers whole again at 70 RMB ($11.29) per LTC for anyone who sold below that level.

Furthermore, the company said, negative balances would be reset to zero – even those still in the red after the 70 RMB redress.

Huobi CEO Leon Li said litecoin volumes had recovered by about 80% since, and users seemed to be satisfied with Huobi's resolution, but predicted that the full 100% recovery would more time.

This incident was very similar to the bitcoin flash crash at BTC-e on 10th February, supposedly induced by panic in the aftermath of Mt. Gox's suspension of all withdrawals. The price of 1 BTC dropped to $100 for just under two minutes, but that was long enough to do damage.

That wasn't the end of Huobi's wild week, however. On Sunday 23rd March, the exchange suffered a crippling distributed denial of service (DDoS) attack that took its site offline for the whole day.

News outside China has been almost non-existent, causing internet sleuths to speculate over whether, if at all, these incidents were related and who might be behind them. Prankers? Blackmailers? Business rivals? Huobi itself? Even Huobi management says it doesn't know for sure, but it insists, as did BTC-e in February, that it did not engineer the crash or profit from it.

Huobi had officially started litecoin trading just two days prior to the crash, and prices had not been spectacular over that time. While LTC had crept higher against BTC and USD in anticipation, actual figures after the launch were underwhelming.

Since the crash, the price has not risen above its pre-Huobi launch level and, on BTC-e, one litecoin is currently trading for around 0.027 BTC, $15.80, and 98.4 RMB, which is almost exactly the same rate.

There have been some other high-profile DDoS attacks in recent weeks, said to be the result of blackmail attempts. Project management site Basecamp (formerly named 37signals) went down just yesterday in what its owners said was an extortion attempt, while Meetup was also taken down a couple of weeks ago after receiving an email saying:

Even if these DDoS incidents are completely unrelated, they point to a recent trend in computer crime: extortion of both businesses and individuals has lately increased, either via overt threats like the one Meetup received or malware like CryptoLocker, which demanded similar amounts from its victims.

Comparing its fate to that of BTC-e, Huobi has published an official response (in Chinese) to the fake news and subsequent crash on its site.

"The system was told to sell at market price, but there were not enough LTC buyers, and transactions could not be completed, so finally the inventory was liquidated at below market prices. When the liquidated LTC was not sufficient to cover borrowings, some small portion of customers experienced a negative asset balance."

"Huobi only opened up LTC trading two days before the 21st March incident, and so there was not enough depth in the market. In the midst of a market panic, there were not many orders that varied greatly from the market price, and so the system could not close positions using normal prices, and it was only when that the price went down to 1 RMB that the position could be closed."

Engineering the crash itself would make no sense for the company, the statement continued, since both buyers and sellers were Huobi customers, and the crash did great damage to the company's brand new LTC trading platform and its reputation in general.

When asked who might have been behind the fake government ban announcement, Li told CoinDesk:

"The fake news was most likely a result of an individual/group maliciously manipulating the price and causing a drop on purpose. They were able to get away with it because people are concerned about the uncertainty in policy."

"To prevent such things from happening in the future, three things need to happen: 1) established media should not publish unverified news about policy; 2) investors need to have basic judgment; 3) the industry should have an authoritative channel for posting news."

Getting traders to act rationally would be an achievement, and is something markets have probably desired for hundreds of years. Controlling media statements on government policy, though, could be easier in China with its vast state-connected media networks.

Huobi is calling for Sina Weibo (a similar service to Twitter) to reveal the owner and Chinese ID number of the 'Caitongshe' account that started the fake rumor in the first place, in the hope it can file a lawsuit.

It is also requesting that any users who bought litecoin for 1 RMB to post pictures of their trades on Weibo (as some have done already). The trades were legal and within the rules, but Huobi wants to demonstrate publicly that the company did not trade at the low price or profit from the crash.

Huobi also insisted that its bitcoin platform remained robust, and did not suffer large setbacks even after the official Chinese government announcement of 5th December, or the fake one of last Friday.

Admitting its risk management strategy for the new litecoin system could have been better, however, Huobi promised improvements to prevent wild fluctuations in future.

To be properly responsible to its customers, the company concluded, after a meeting with all stockholders, Huobi has agreed to use a portion of its loan loss provision funds to cover losses suffered by the exchange's users.

This story was co-authored by Rui Ma (@ruima).