On Tuesday (2 October 2018), the Wall Street Journal (WSJ) reported that “trading bots” (automated trading software) are behind some of the price manipulation on crypto exchanges.
Price manipulation on crypto exchanges has been a “growing concern” for regulators, traders, and investors across the globe.
On 24 May 2018, Bloomberg reported that the U.S. Department of Justice (DOJ), in conjunction with the U.S. Commodity Futures Trading Commission (CFTC), had “opened a criminal probe into whether traders are manipulating the price of Bitcoin and other digital currencies.” The report said that, according to its sources (four people familiar with the matter), the Justice Department was investigating “illegal practices that can influence prices — such as spoofing, or flooding the market with fake orders to trick other traders into buying or selling.” Another price manipulation tactic mentioned was wash trading. The report also mentioned that authorities “worry that virtual currencies are susceptible to fraud for multiple reasons: skepticism that all exchanges are actively pursuing cheaters, wild price swings that could make it easy to push valuations around and a lack of regulations like the ones that govern stocks and other assets.”
On the same day that the Bloomberg article was published, Mike Novogratz (CEO of crypto merchant bank Galaxy Digital LP), Cameron Winklevoss (President of the Gemini digital asset exchange), and Tom Lee (Head of Research at Fundstrat Global Advisors) welcome news of the investigation.
Novogratz told Bloomberg in a phone interview:
“Weeding out the bad actors is a good thing, not a bad thing for the health of the market… Plenty of exchanges have these inflated volume numbers to create some sense of excitement around coins.”
Winklevoss said via an emailed statement:
“We welcome any inquiry that serves to foster rules-based marketplaces and deter bad actors.”
And also via email, Lee said:
“This is really welcome news ultimately because this means there is adult supervision coming/here.”
As for the U.S. Securities and Exchange Commission (SEC), on 22 August 2018, as covered by CryptoGlobe, it announced that it had rejected nine Bitcoin ETF proposals, and one of the main concerns expressed in all three disapproval orders was price manipulation (“fraudulent and manipulative acts and practices”).
It is important to note although the CFTC, which views cryptocurrencies as commodities, does not regulate spot markets, if it finds evidence of fraud, it does have the power to impose sanctions. Most recently (on 14 September 2018), its current Chairman, J. Christopher Giancarlo, whilst speaking to CNBC at the annual “Singapore Summit”, said that although regulators should take a “do no harm” approach to the crypto space (to allow it to flourish), caution was needed to prevent fraud and manipulation in the crypto markets:
“When it comes to fraud and manipulation, we need to be strong. When it comes to policy making, I think we need to be slow and deliberate and well informed.”
Also, on 18 September 2018, the New York State Office of the Attorney General (OAG), released the “Virtual Markets Integrity Initiative Report”, in which one of the key findings was that crypto exchanges had, for the most part, not made any serious efforts to prevent “abusive” trading activity:
“Though some virtual currency platforms have taken steps to
police the fairness of their platforms and safeguard the integrity of their exchange, others have not. Platforms lack robust real-time and historical market surveillance capabilities, like those found in traditional trading venues, to identify and stop suspicious trading patterns. There is no mechanism for analyzing suspicious trading strategies across multiple platforms. Few platforms seriously restrict or even monitor
the operation of “bots” or automated algorithmic trading on their venues. Indeed, certain trading platforms deny any responsibility for stopping traders from artificially affecting prices. Those factors, coupled with the concentration of virtual currency in
the hands of a relatively small number of major traders, leave the platforms highly susceptible to abuse. Only a small number of platforms have taken meaningful steps to lessen those risks.”
Coming back to the WSJ report on price manipulation by bots, it noted that although bots, which can be used for “both legitimate and manipulative strategies”, also exist for more established markets such as the New York Stock Exchange (NYSE), the difference is that while those heavily regulated exchanges “monitor for illegal trading and punish rule-breakers”, lack of strong “surveillance efforts” on crypto exchanges (which are either unregulated or very lighly regulated) means that “crypto bots can be used to execute abusive strategies on an industrial scale.”
Stefan Qin, a Managing Partner at Virgil Capital (a multi-national, multi-strategy quantitative firm focused on trading cryptocurrencies), which “runs its own bots on dozens of crypto exchanges world-wide” told WSJ that he is engaged “in a constant cat-and-mouse game with enemy bots”. He added: “We’ve had to build in error-handling functions to check for hostile and potentially illegal activities. Such is the Wild West of crypto.”
Qin said that earlier in the year, his firm had lost money on some trades in Ether (ETH) after a “harassing bot” targeted the firm’s hedge fund, which specializes in crypto exchange arbitrage. A few seconds before Virgil’s once-a-minute price discrepancy check, this enemy bot would “post orders to sell ether at a lower price than other sellers”, which would cause Virgil to try to buy that Ether, but before it would get the chnce to do it, the hostile bot would cancel the sell orders, which meant that Virgil would post buy orders that would not get executed, but would briefly cause the price of Ether to rise on some crypto exchanges.
What the hostile bot was doing was a manipulative practice known as “spoofing”, a tactic “outlawed in U.S. stock and futures markets in 2010” aimed at “tricking other investors to buy or sell an asset by falsely signaling there is more supply or demand.”
Virgil was forced to modify its trading algorithms to stop being “gamed.”
WSJ says that Norwegian Bitcoin trader Kjetil Eilertsen has created a program called “Quatloo-Trader”, which he refers to as “the best market-manipulation tool in the world of crypto.” Eilertsen believes that it is a waste of time to try to ban crypto price manipulation, and that it would be better to “level the playing field by giving sophisticated manipulation tools to small traders”. He told WSJ:
“If everybody can manipulate, then nobody is manipulating. You can’t ban anything from people who are dedicated to doing something.”
Quatloo-Trader has a tab called “whale Tasks,” which contains “automated tools for executing several abusive strategies”; one of these, which is called “Ping-Pong”, enables “wash trading” (a practice considered illegal in the world of stocks and futures) by auto-placing buy/sell bids to create “a mirage of intense activity in a particular cryptocurrency.”
A former user of the program, Ryan Wright (a U.S. citizen based in Taiwan) told WSJ that he “liked how the program allowed one person to execute trades across several accounts simultaneously”, making it appear as though multiple people were buying and selling, when in fact it is just one person. However, he says that he stopped using it last year over concern about “regulatory scrutiny.”
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