Market manipulation is not unique to crypto trading, but it does get special attention in crypto because of its relative “newness” to finance and how it is regulated differently around the world. Learning about this topic can help investors and traders recognize the involved risks and manage them more effectively.
What Is Market Manipulation?
Market manipulation in crypto is much like the manipulation of any asset in any market. It can be defined as an intentional action that artificially affects an asset’s price for personal gain.
Manipulation can cause a crypto’s price to rise or fall depending on the manipulator’s goals. If the manipulator intends to buy more, then they will aim to create a price drop. If they are already holding a large amount of the asset, then they will aim to create a price rise. Exchanges can also participate in market manipulation by including fake orders or excluding orders.
Types of Market Manipulation
There are many types of manipulation, most of which are illegal. Here are some of the most common:
Pump & Dump
- Pump & Dump is when a trader that already has a position in a cryptocurrency tries to make the price rise so they can sell off their position. One way to do this is by purchasing a large amount of the available crypto asset, which can create false demand and attract other traders to buy. Another method is when an influential person or group relays false information to convince traders that a cryptocurrency is more valuable than it actually is to inflate the price. In either scenario, once the price has risen, the manipulator can sell off their position at the higher price. This is the form of cryptocurrency market manipulation that most individuals have been prosecuted for.
- Wash Trading refers to making a large number of buy and sell orders for a particular cryptocurrency to create the illusion of a more active market. This can attract new traders to the market for a specific crypto that would otherwise not get much attention. This form of market manipulation is typically reserved for cryptocurrencies or exchanges with less trading activity since it would be difficult with an already active market.
- Cross Trading happens when a trade occurs but is not posted on the market, thereby keeping the trade’s value from affecting the crypto’s ask price. In cryptocurrency, this can only happen if the exchange itself allows cross trades or is colluding to manipulate the market.
Layering & Spoofing
- Layering & Spoofing is when a trader places fake buy or sell orders that they do not actually want to close. This form of market manipulation creates an illusion of the involved crypto’s supply and demand. The manipulator’s goal is to influence other traders to act on this false data and buy or sell the targeted asset. Once the price moves toward the manipulator’s desired price, they cancel their fake orders.
- Whale Moves are considered a form of market manipulation in crypto. A crypto whale is an individual who has such a large amount of a particular cryptocurrency, that when they trade they independently cause big shifts in the market. However, whale moves are considered market manipulation only if the whale makes a trade with the purpose to change the price for their own benefit.
When Has Crypto Market Manipulation Happened?
Market manipulation is difficult to detect and prove. Even when it is obviously happening, authorities can’t always identify who is responsible. That said, the United States Securities and Exchange Commission (SEC) has indeed charged individuals for crypto market manipulation many times. For example, on June 11, 2021, an individual behind the now-defunct Apis Tokens was charged with fraud. The individual had fraudulently claimed that the company backing the project was preparing to purchase an artificial intelligence company. This increased the value of the project, which allowed the individual to sell off his position for more than its actual worth — a classic Pump & Dump scheme.
Although Pump & Dump is usually attributed to influential people, it can also happen when groups of regular traders band together to influence the market. Some of these groups, such as the one in the image below, are made specifically to manipulate the market.
Communications of a Pump & Dump group and the subsequent market activity (Source: Springer)
This Rocket pump Telegram group communicated and gave their members early notice that they were preparing for a Pump & Dump. The group admins decided to target YOYOW (YOYO) coin, but waited until the last minute to release this information. This is to provide some exclusivity so that only group members can react quickly enough to the scheme. Any traders outside of the group that may receive the information secondhand would have less time to acquire the coin before the dump happens. The graph above on the right shows how quickly the Pump & Dump happened, with the rise and fall of the price happening between 17:00 and 18:00. This allowed the traders participating in the scheme to dump their positions at the highest price possible before the coin corrected itself to its actual market value.
Another alleged instance of market manipulation happened on May 17, 2019, for Bitcoin (BTC). A trader placed a large sell order on the Order Book at about 6% below the market price. Since other trades had Limit Orders to buy at lower prices, those orders began to fill, which lowered the ask price on the exchange. As the ask price dropped, it began triggering other Limit Orders that were set to sell a position if a price was reached. This caused a chain reaction as Limit Orders and active trades drove the price down well below the price of the trade that triggered the sell-off. Whoever made this first trade would be able to buy back what they sold at a lower or equal price to their original sale and then sell at a profit once the market corrected itself.
How to Prevent Crypto Market Manipulation?
As cryptocurrency moves toward widespread adoption, many institutional actors are bringing more legitimacy to the industry by developing related technologies. For example, Nasdaq has introduced three solutions that can be used to address market manipulation in crypto:
- Nasdaq Market Surveillance (SMARTS) is designed to detect and analyze any marketplace abuse and visualize trading activity for review. Its primary purpose is to consolidate data into a simple snapshot that helps investigators identify potential abuse.
- Nasdaq Marketplace Services Platform provides a cloud-based service that allows exchanges to operate in the cloud. Built using Nasdaq’s own Financial Framework, the platform is intended to streamline operations and consolidate exchanges under a single trusted source.
- Digital Assets Suite is a crypto-specific solution aimed at digital assets. It was built using an enterprise blockchain platform that facilitates the entire lifecycle of any digital asset. This solution can also be integrated with the Nasdaq SMARTS solution to provide surveillance.
These are just some of many solutions that are being presented by financial institutions, and many more are in development as crypto adoption increases.
What Can Trades Do to Prevent Market Manipulation?
Holders – Hodl your crypto
There are always risks involved with trading in any asset and in any market. The best thing to do is to always understand your investments and use strategies to reduce your risk. Market manipulation is mostly concerning for short-term traders. If you plan to HODL, then market manipulations have less power to affect your position, since their effects happen quickly before the market corrects itself.
Short-term Traders can monitor the ratio between long/short positions
This doesn’t mean short-term traders can’t protect their positions. By learning to recognize common types of market manipulation, you may be able to minimize their effects on your investments. One way to identify potential manipulation is by monitoring the ratio between long and short positions on the market. When the ratio of long positions to short positions is higher than usual, a dump may be about to happen. When the opposite is true, a pump may be happening. You should look at different periods of time to see if there are sudden changes in either direction.
Crypto portfolio balancing
Another strategy for dealing with market manipulation is to reduce your risk by not investing all of your assets into a single cryptocurrency. Crypto portfolio balancing is advised for any investor to make sure their portfolio includes a healthy mix of crypto assets. In this case, even if one of your crypto assets is affected by market manipulation, it will only be a limited portion of your total crypto assets.
Select a trusted exchange
Lastly, make sure you are always trading on a reliable exchange with a good reputation. New exchanges or exchanges that have less trade activity are more susceptible to market manipulation.
Like any other investment, investing in cryptocurrencies involves risks. However, any type of market manipulation that happens in cryptocurrency mostly relies on the fact that crypto is a nascent industry that is inconsistently regulated. Market manipulation will become more difficult as the technology improves and traders become more informed. The best thing any crypto investor can do is to always perform due diligence on any crypto asset and exchange before trading.