Trading Bots As Barrier To Crypto Market Development
Mainstreaming of automated cryptocurrency trading bots pose risks to the cryptocurrency market much more than to the financial one. We have already brought it up in the previous article, and today we'll consider this issue in detail. Unfortunately, the use of cryptocurrency trading bots is one of the main reasons for the constant fluctuations of crypto assets prices.
The cryptocurrency market is a drop in the bucket of the global cash flow. Financial and stock markets are much older than the cryptocurrency one. The vast sums of money are spinning there, and regulation is way more strict. Expedients that have long been banned in the financial market are still acceptable when trading crypto. This opens up a lot of scope for price manipulation. As a result, a small group of users is enriched by using manipulative cryptocurrency trading strategies and influencing prices, hence reducing the general confidence in the crypto sphere.
As Andy Bromberg, CEO at CoinList, the largest fundraising platform for ICO projects, pointed out about the issue of cryptocurrency trading bots in his interview with The Wall Street Journal,
“This sort of activity is rampant in the market right now. It hurts the market’s reputation, and it hurts individual investors."
As an example, he put a case with Virgil Capital, a cryptocurrency hedge fund.
Spoofing and its impact on the crypto market
The total customer capital of Virgil Capital hedge fund established in 2016 is estimated at $800 million. In 2018, the fund lost significant amounts on crypto exchanges due to the high use of manipulative cryptocurrency trading strategies with automatic bots by other traders.
This tactic is called spoofing, and the example given above is just one of many known cases of its use. How the spoofing scheme works:
- A scammer places an order (or several orders) for a large amount at a price that is significantly higher or lower than the current asset value; there are dummy orders.
- It creates an artificial agiotage: other traders see large orders and follow the market. They start buying or selling a cryptocurrency en masse.
- At the same time, the fraudster creates real orders taking an advantage of the market movement.
- The scammer cancels dummy orders, closes the real ones and receives a profit, while other traders suffer losses.
Sometimes, the amount of such dummy orders reaches $60 million, which clearly shows how common this scheme is. Ordinary market participants can't afford fictitious trading with such a big sum. In the stock market, spoofing has been prohibited since 2010, when the Dodd-Frank Act was passed. Of course, attempts to manipulate prices, including spoofing, still can be found there. But unlike the cryptocurrency market, there are means that allow identifying scammers.
Fraudsters use cryptocurrency trading bots for spoofing, it allows them to place multiple orders simultaneously. This is exactly the situation that the Virgil Capital fund encountered. After that, a hedge fund manager suggested to use bots for spoofing as well as to withstand a competition with fraudsters. As a result, there were even more crypto market participants who manipulated the assets value.
This leads to the disappointing conclusion that the rocking of the market badly impacts the public image of the crypto sphere, while the use of bots becomes more and more common, which makes the problem even worse.
Fighting price manipulations
Spoofing is not the only manipulation tactic that exists in the crypto market, but it is definitely one of the most common. Alas, crypto exchange users aren't protected from fraudsters, and the reason is the lack of strict control over the activities of trading platforms, as price manipulations and other fraudulent schemes are rarely tracked by anyone.
The problem is perfectly illustrated by the Virtual Markets Integrity Initiative report of the New York State Attorney General Barbara Underwood, dated September 18, 2018. During the research of online trading platforms’ activity, the most popular crypto exchanges were surveyed. Not all exchanges agreed to cooperate and provide information on some issues, including those related to the detection of price manipulations. Only a few of them have developed their own policy for detecting automated manipulative trading, but this does not protect their clients whatsoever. The market is a united area, and changes in the cryptocurrency value on one platform affects the other.
The illustration below shows the answers given by exchange representatives to the following questions:
- Are automated trading rules defined on the stock platform? If they are not, the management of the exchange does not seek to protect its customers.
- Is there a limit on the number of messages exchanged between users of the platform? High messaging activity is a signal of collusion between traders aimed to influence an asset price.
- Are small orders tracked? A large number of buy or sell orders placed at the same time is a sign that someone tries to manipulate the market.
As you can see, a rare trading platform takes care of its customers without regulative control. As the report shows, only four platforms have a formal policy defining the procedure for detecting price manipulations. These are Bittrex, Coinbase, Gemini, and HBUS.
No matter what manipulative tactics are used, they are all detrimental to the development of the crypto sphere — if only because they don’t allow institutional investors to enter the market. In 2018, there were numerous attempts to raise the issue of bitcoin exchange-traded funds (ETF) trading. But the SEC is not in a hurry to give a green light to this kind of activity because of the high volatility of bitcoin and constant speculations on its value.
In the interim, unscrupulous traders throw sand in their own wheels. Once large investors enter the market, it will immediately have a positive effect on the value of crypto assets. But nothing will change as long as the market is too volatile.