The Vulnerability of the Cryptocurrency Industry and Different Types of Market Manipulation
The crypto market allows users to have direct interaction with exchanges, a trading climate where market users can conduct pseudonymous transactions, without supervision from intermediaries. While regulations and policies have cracked down on certain types of market manipulation, there continue to be many suspected cases of market manipulation.
What is Market Manipulation?
Market manipulation is the illegal act of influencing the market for an opportunity for profit through the act of manipulating the price or determining market behaviour. The manipulator aims to deceive other players of the market so as to create an opportune moment to profit - when there is an over or undervaluation of the market price. There are many various forms of manipulation in the market. Some examples include:
1. Pump and Dump
Cryptocurrency pump and dump schemes arise when an individual or a group of investors aim to profit by pumping an asset into the market. Traders utilise both regulated and unregulated exchanges to impact the price of cryptocurrency by buying or selling huge amounts of virtual assets.
“Pumping” refers to a large purchase of coins to instigate a shortage and cause an upward push on price. Other buyers go into a frenzy as they wish to capitalise on the high prices and subsequently, send the demand of the coin up. At the maximum price peak, the instigators will “dump” by selling off all their tokens and cause a price dip.
In summary, the market dynamics of supply and demand are exploited to feed misleading information to investors. This scheme is mostly applied to unfamiliar but promising new coins that require little capital to manipulate.
2. Wash Trading
Wash trading occurs when an investor sells and buys the same financial instrument simultaneously to feed artificial market signals in the crypto industry, Often, they target instruments that are traded in low volumes or smaller trading platforms. Blockchain Transparency Institute research reported that 80% of the top 25 trading pairs for bitcoin in crypto exchanges in 2018 were wash traded. Cryptocurrency exchanges came under fire in 2020, when direct evidence of ‘bitcoin wash trading’ appeared.
In a report released by Neoma Business School and George Mason University, which utilised leaked traderl records from the now-suspended Mt.Gox - which at its peak was the world’s largest Bitcoin intermediary and leading exchange platform. Evidence found that the exchange was committing wash trading to inflate trading volume and boost fee revenues.
3. Spoofing and Layering
Spoofing occurs when traders indicate their interest to bid or offer with the intent to cancel before it goes through. By artificially reflecting their willingness to buy or sell, the market is fed false or misleading signals and reflects incorrect demand and supply levels in the market.
Layering is a variant of Spoofing. The trader manipulates the price point of the market by executing orders on opposing ends and at multiple price tiers. It utilises the basic microeconomic principle which explains that when there are more buyers and sellers, prices will correspondingly fluctuate up and down.
Market inefficiencies are unavoidable in the still relatively new cryptocurrency industry. This is where regulations need to step up to combat any instances of market manipulation. Regulations require time and multiple iterations before it is sufficient to tackle vices in the industry, this is especially so for the dynamic FinTech industry. The integration of digital assets into other industries means that corporate entities may find it challenging to keep up with constantly changing regulations. Hence, Regulatory Technology is there to fill in the gaps, work as a positive innovator for the compliance horizon, and safeguard the market’s welfare from instigators of malicious intent.
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