Last week, the publishing of an academic paper all but confirmed bitcoin market manipulation. The authors, from the University of Texas at Austin, investigated the behavior of the exchange Bitfinex and their relationship with Tether (USDT). The paper suggested that there is a high probability that the great Bitcoin bull run of 2017 may have been the result of market manipulation.
Market manipulation in the bitcoin markets may not come as a surprise to many in the industry, but not everyone really knows how it’s done. After all, Bitfinex is not the only culprit if they did successfully have any effect on prices (though others are more hesitant to take the study as ‘authoritative‘). Other lesser known parties are able to manipulate smaller cryptocurrencies too. Today, we’re looking at how large investors and institutions can potentially manipulate crypto markets. There are two main methods of manipulating pricing that we’re discussing today: wash trading and spoofing.
Wash trading and spoofing are two forms of manipulation the Securities and Exchange Commission (SEC) have stated they’ll be looking for in the markets. Let’s take a look at them below.
Market Manipulation: Spoofing
Spoofing is one of the most common ways large investors and traders can manipulate the market. Since we’re talking about cryptocurrencies, it’s important to note that a “large investor” does not necessarily mean a large financial institution.
In the crypto markets, you’ve likely heard of a “whale” before: these are the large investors who can manipulate markets. A “whale” is simply a person (or group of people) holding a large amount of a cryptocurrency. Though there are no specific definitions, a whale holds a reasonable percentage of the specific crypto in circulation. One of the ways a whale/group of whales can manipulate the pricing is by spoofing the market.
A “spoof” is defined as a hoax or trick, and that’s exactly what this trading is. The way it works is actually pretty simple. A whale can place large buy or sell orders and place them on the books for later. Then, when traders look at the open order books, it looks like there is a lot of demand! That demand can either be to buy or to sell that crypto.
However, as the price starts moving in the direction the whale(s) want, they will go and cancel the spoofed order they placed so it never executes. Effectively, the whales are able to make it look like there is demand for a specific cryptocurrency in one direction or the other, even when there is significantly less natural demand in the markets.
This practice exists outside of the cryptocurrency world as well. In fact, a recent case involved some big-name financial institutions getting slapped with large fines for doing it!
Market Manipulation: Wash Trading
The next common way bad actors manipulate crypto markets is through wash trading. Wash trading is where a trader does a lot of buying and selling in the market, but they’re all with himself. Whales holding onto large amounts of a crypto sell to themselves and buy from themselves in the markets. At the end of the trade, the trader is essentially ending with a “wash,” since the money he paid for the coins is going right back to him. But why would anyone buy and sell to themselves for no money and rack up all those fees?
Again, the concept is actually simple. By buying and selling large amounts, the manipulator has an advantage. Those orders create an appearance of high demand and high liquidity in the market. Often manipulators will choose smaller cap coins. Those coins are much easier to manipulate and take advantage of other traders in.
If the manipulator can convince others that there is a lot of demand and volume, then other traders will likely want to get in. After new traders start getting in on the high volume, the manipulator can dump all of his holdings on to the new traders and leave. Once the manipulator is gone, all of the liquidity and demand suddenly vanishes. The unsuspecting new traders are left holding the whale’s coins in a market with no liquidity.
Isn’t That Illegal?
Though the cryptocurrency markets remain relatively unregulated, these actions are still very illegal. At the moment, there isn’t a lot of enforcement in the markets. However, that’s just because regulators haven’t decided on a unified approach to take with the new asset class yet. They’re still watching while they’re deciding though.
The important thing to know as a smart trader is that even though market manipulation is present in the markets, it’s a bad idea. Regulators in North America and elsewhere are now cracking down on market manipulation. The cryptocurrency markets are no longer a safe haven for illegal activity in the markets.
Both the SEC and CFTC in the US are investigating cases of market manipulation now in the crypto markets. The SEC, CFTC, and other regulators are all looking out for cases of market manipulation now, and you should be too.