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Market manipulation undermines market integrity and refers to the action of controlling or artificially influencing prices and is generally illegal. With the emergence of new markets, such as those for cryptocurrency and digital assets more generally, there is a new light cast on market manipulation. Despite cryptocurrency markets being relatively young, there has been no shortage of manipulation violation claims that could ultimately impact investors. This article provides an overview of cryptocurrency manipulation, types of manipulation affecting cryptocurrency, and the impact such manipulation can have on the market.
Understanding Cryptocurrency Market Manipulation
Cryptocurrency market manipulation involves practices that are designed to influence cryptocurrency prices and can result in artificially inflated or deflated prices as compared to the prices that would have prevailed under normal market conditions. Some common manipulation tactics affecting crypto markets and financial markets more generally are pump-and-dump schemes, spoofing, wash trading, and insider trading. While enforcement in cryptocurrency markets undertaken by the Securities and Exchange Commission (“SEC”) has been on the rise, regulation and enforcement of cryptocurrency markets lags behind that in more established and mature financial markets such as stock markets. As a result, cryptocurrency markets might be prone to manipulation.
Trading in cryptocurrency markets can be done so with a level of anonymity that differs from other financial markets. This aspect further facilitates market manipulation, because it is difficult to identify or trace the actions of perpetrators. This complicates the assessment and detection of any alleged manipulation both in terms of the extent and impact. This anonymity, combined with the decentralized nature of many cryptocurrency transactions, allows perpetrators to operate with a level of impunity that is less common in traditional financial markets. Such activities can significantly impact prices and lead to rapid fluctuations that can harm investors.
Types of Cryptocurrency Market Manipulation
Market manipulation with respect to cryptocurrency encompasses numerous strategies that exploit vulnerabilities within market structures, ultimately impacting the price of a given cryptocurrency. Tactics such as wash trading and pump-and-dump schemes are designed to mislead investors by creating false impressions about market conditions in the crypto landscape.
Acknowledging and understanding these various potential forms of manipulation is essential for spotting potential risks and implementing measures to safeguard against attempts at distorting normal trading activity within the cryptocurrency market.
Pump and Dump
Pump-and-dump schemes is one of the more common types of manipulation impacting more traditional investments such as stocks. These manipulative practices often arise during an Initial Coin Offering (ICO), where exaggerated claims boost demand and allow insiders to cash out with profits. The price of a cryptocurrency can be artificially elevated through promotional tactics, leading to insiders selling their stakes at high prices before a sudden market collapse.
Pump-and-dump schemes usually commence with efforts to stir up enthusiasm prior to launch, which then transitions into coordinated selling that precipitates a dramatic drop in prices. In 2023 alone, it was reported that 90,408 tokens were flagged as being involved with pump-and-dump schemes. These schemes have been suggested to net $241.6 million in profits.1
The detection process for uncovering these activities involves analyzing and scrutinizing transactional data from blockchain ledgers. This can be a sophisticated process and often requires a cryptocurrency expert well versed with analyzing large amounts of data.
Spoofing
Spoofing is another market manipulation tactic that can and has impacted cryptocurrency markets. This manipulation tactic entails creating artificial orders to influence market prices. This tactic involves generating the illusion of optimism or pessimism in the market. This can be done by initiating sizeable orders with the intention of never filling them to represent demand and then withdrawing those orders prior to execution. The same can be said for sales orders. As a result, there is an illusion of activity in the market which can attract other traders into taking action based on this misleading information.
Spoofing distorts market conditions and can sway pricing dynamics within trading platforms. Such distortion not only skews genuine market trends but also erodes confidence in the cryptocurrency or exchange itself. For cryptocurrency investors, it is important to be aware of spoofing signals such as large buy or sell orders that are not fulfilled. In addition, it is important to be aware of shifts in markets that could signal market manipulation in the form of spoofing.
Accurately detecting spoofing can be quite challenging and typically requires analyzing vast amounts of trading data including bid and ask prices and volumes. With such data, a cryptocurrency expert can analyze bid and ask patterns alongside transactional trading data to isolate indications of spoofing. In addition, a crypto expert must be well versed in quantifying the impact on market participants due to the deceptive practice of spoofing.
Wash Trading
Wash trading is another type of market manipulation scheme that can impact the cryptocurrency market. Wash trading entails a crypto trader buying and selling the same cryptocurrency to create misleading activity and inflate perceived market demand. This practice involves a crypto investor simultaneously selling and buying the same asset, creating a false impression of market activity without any real change in ownership. Wash trading can be employed to manipulate market prices, leading to potential gains for the perpetrator while misleading other investors.
Wash trading has impacted some high-profile names in the cryptocurrency space including the trading platform Binance which the SEC claims misled investors due to in part to alleged wash trading. According to the SEC, Binance.US falsely stated it had protocols in place to monitor and prevent wash trading when in fact one of its own market makers, Sigma Chain, an entity controlled by Binance’s owners, engaged in wash trades.2
As with other forms of market manipulation, detecting and regulating wash trading in the crypto space poses significant challenges. Wash traders attempt to artificially boost liquidity to attract investor interest in an exchange and/or cryptocurrency in order to manipulate prices. Detecting wash trading requires analyzing data on trading volumes that may be out of sync with liquidity metrics such as bid-ask spreads or order book depth. Evidence of a potential misalignment should prompt gathering and examining more detailed transaction data on exchange participants to determine if the anomaly is being driven by active investors with zero net positions.
Insider Trading
Insider trading has often plagued financial markets so it should come as no surprise that insider trading could also occur in cryptocurrency markets. Insider trading occurs when individuals share and use non-public information about a crypto asset to manipulate the market. This conduct arises from using privileged knowledge regarding significant market-moving events, such as announcements of new cryptocurrency listings or major news impacting a cryptocurrency.
As part of their efforts to tackle insider trading in digital currencies, regulatory authorities have begun prosecuting those involved by filing charges not only specific to securities laws, but also including other criminal violations like wire fraud. An example includes a marketplace manager at an NFT platform who faced allegations that he exploited non-public details concerning which NFTs would be prominently displayed next and traded them based on this info.3
Insider trading can be extremely hard for the typical investor to spot. In many cases, an investigation is required to detect insider trading activity and to what extent it impacted the market. The investigation requires gathering and analyzing detailed historical trading activity of the alleged insider, separating trades based on public and non-public information, as well market price information to assess the profitability of their trades.
Some Recent Cryptocurrency Market Manipulation Cases
In May 2023, Ishan Wahi became the first individual to be sentenced for insider trading related to cryptocurrency after leaking information about upcoming crypto listings on Coinbase. This landmark case highlighted the regulatory efforts to curb insider trading within the cryptocurrency market.4
Another significant instance of market manipulation occurred in December 2022, when the SEC charged leaders of Alameda Research and FTX for manipulating the price of FTX’s FTT token through large market purchases.5 This case underscored the risks of price manipulation and the importance of regulatory oversight in maintaining market integrity.
In October 2022, the manipulation of the price oracle referenced by Mango Markets allowed a trader to expropriate $115 million in digital assets, highlighting vulnerabilities in decentralized exchange (“DEX”) platforms.6 A DEX allows market participants to trade a wide variety of cryptocurrencies and uses complex mathematical algorithms for pricing (see Econ One blog post “Decrypting Cryptocurrency by Focusing on Decentralized Exchanges”).
In the case of Mango Markets, the trader manipulated the prices of Mango Market’s governance token MNGO by manipulating the prices feeding a price oracle, an algorithm used by Mango Markets to help price its MNGO token by gathering prices from outside sources, such as other exchanges.
These notable cases demonstrate the various tactics and complexity used in market manipulation and the ongoing efforts by regulators to address these issues and protect investors.
Impact of Cryptocurrency Market Manipulation on Investors
Investors can face severe losses due to price fluctuations caused by manipulation, exacerbating the volatility of cryptocurrency markets. These manipulative practices can erode trust in the cryptocurrency market, hindering the realization of a decentralized and well-functioning financial system.
Because manipulation can be difficult to detect and quantify the potentially enormous impact it can have on markets (recall the LIBOR interest rate benchmark manipulation scandal that took years to be uncovered), investors can suffer financial harm despite conducting their own research and due diligence.
Econ One financial and economic experts have assisted investors uncover, challenge and quantify the impacts of price manipulation (including benchmark manipulation) in many markets including financial products.
The Role of a Cryptocurrency Expert to Assess Impact
Cryptocurrency experts are instrumental in detecting and scrutinizing market manipulation tactics that can undermine the lawful and efficient price discovery on cryptocurrency exchanges. They can apply their understanding of conventional strategies for market manipulation to the realm of digital assets and blockchain commerce. Using sophisticated analytical methods and data analysis, as well as economic and financial models, an expert can uncover indications of manipulative practices that may pose risks to investors. In addition to uncovering actual manipulation, an experienced crypto expert can design models and analyze large amounts of data to quantify the harm associated with the illicit manipulation.
Econ One’s cryptocurrency experts span a unique background in finance, computer science, data analytics, artificial intelligence, and machine learning. We utilize modern day analytic tools and programming expertise to evaluate very large datasets and make sense of even the most complex cryptocurrency trading data.
Summary
Market manipulation in the cryptocurrency space takes many forms, from pump-and-dump schemes to insider trading and wash trading. These practices distort market dynamics, leading to significant financial losses for unsuspecting investors and undermining trust in the crypto markets. Understanding these manipulative tactics and the regulatory efforts to combat them is crucial for anyone involved in the cryptocurrency sector.
As the regulatory landscape continues to evolve, the role of cryptocurrency experts becomes increasingly important. By providing the relevant insights into market dynamics and trading activity, an expert can help analyze allegations of cryptocurrency manipulation and quantify the impact of the manipulation.
Frequently Asked Questions
What is cryptocurrency market manipulation?
Cryptocurrency market manipulation involves skewing the value of cryptocurrencies by engaging in fraudulent tactics, including wash trading, spoofing, and pump and dump schemes. This results in investors receiving false indicators about price movements. These deceptive practices compromise the legitimacy of the market by disrupting its efficient price discovery function and the ability of investors to make optimal investment decisions.
What are some examples of notable cryptocurrency market manipulation cases?
Cases of market manipulation in the cryptocurrency market that have garnered attention include the conviction of Ishan Wahi for engaging in insider trading at Coinbase, the SEC’s allegations against Alameda Research and FTX for manipulating the price of their FTT token, and an incident where a trader manipulated a price oracle at Mango Markets to secure a profit of $115 million.
Why makes market manipulation difficult to detect?
The perpetrators of market manipulation schemes are often deeply embedded in market trading and can seek ways to evade monitoring and detection by even sophisticated oversight authorities. Recall the LIBOR scandal was not proven until years after it was initially detected through careful analysis of benchmark price data and market trends. In cryptocurrency, as in many securities and complex financial products, investors relying on market integrity would not necessarily have the skill, resources or time to uncover misbehavior, which is a role that cryptocurrency experts specialize in every day.
