As the global economy continues to be familiar with the reality of digital currency, some underground tactics are coming into the spotlight. Cryptocurrency spoofing is one of the issues gaining a lot of popularity among Bitcoin investors and a major cause of alarm for many traders.
This underground tactic is practiced by large algorithms and market whales to fool the market and manipulate the price. However, with the government trying to get hold of this lucrative market, it has now grabbed the attention of U.S regulators (CFTC). It has further sparked a hot debate about market practices in unregulated markets.
So, What Is Spoofing?
Spoofing is not a new practice in the cryptocurrency market. Also known as dynamic layering, it’s widely practiced in other markets including stock and commodities. It’s basically a strategy used by high-frequent traders (HFT) with the intention of manipulating the price of a specific instrument. That’s possible through the manipulation of the market’s perception of demand and supply for the said asset.
Just like other underground market practices adopted by market whales, spoofing aims to make a profit by moving the market slightly. However, excessive spoofing is known to cause catastrophic market movements like the 2010 flash crash of the Dow Jones.
A Spoofing Primer
While spoofing can give traders great profits, practicing such strategies in a regulated market implies high risk. That’s because the regulators can trace the order books back to the trader and identify any malpractices. However, the bitcoin market has no central regulators, making it easy for traders to establish exchanges and create orders to influence the price anonymously.
As with other securities, bitcoin’s price depends on many factors. That includes the prevailing pessimism of other cryptocurrencies and the general sense of optimism among individual investors. While this momentum is difficult to substantiate, it’s nevertheless something that savvy traders have been accustomed to. That’s because the feeling of optimism or pessimism can influence a trader’s decision on whether to buy or sell their virtual tokens.
The fact that such sentiments remain elusive in determining the price of any token makes it possible and useful for manipulating bitcoin. Traders do that by initiating sell or buy orders without the intention of filling such orders and tricking average investors to either buy or sell. The trader later cancels the order after the price moves to the desired direction.
Bitcoin Spoofing in Practice
Bitcoin spoofing is something that is quite easy to notice after it has already taken place. Mostly, you can note big sell or buy wall of orders that try and sway the investors’ interests in buying or selling this digital currency.
For market whales to make the average investor dispose of their virtual assets, they are known to place large sell orders and terminate them later. For savvy traders, this can be very intimidating, and they will choose to either sell their bitcoin or withdraw their pending buying orders. The spoofer will then buy the coins getting sold by panicked investors and completely cancel his sale orders.
According to the DOJ, exchanges around the globe are taking active measures to root out investors engaging in spoofing. The authorities are also looking into other strategies to manipulate bitcoin’s price like Wash trading. This tactic is similar to spoofing but different in that the trader carries out the transactions within a single entity to create the illusion of demand and attract unsuspecting investors to the trade.
Algorithmic Bitcoin Spoofing
In a world where technology continues to improve every day, advanced trading algorithms and exchange APIs are becoming popular in cryptocurrency investment. Today, most spoofing cases are as a result of bots and automated algorithms. In fact, there are allegations that an automated trading bot called “Picasso” is responsible for the December 2017 market bull run.
For price manipulation, the spoofer programs the bots to swiftly kill open orders without risking to shift the price in the opposite direction. It’s also possible to integrate API access on the trading bots to give you an execution edge compared to the rest of the traders.
While spoofing is common in the cryptocurrency market, spotting it is not that easy. What investors can see are huge orders in the books, but there is no way to verify their legitimacy. However, you can avoid the risk by avoiding exchanges that are known to work in highly secretive terms.
To avoid falling victim to bitcoin spoofing in an unregulated market, investors should also tread cautiously. As a trader, you can carefully watch the market for several days before choosing whether to buy or sell. You will want to note of any sudden changes in the market and check whether orders are disappearing and appearing regularly. That will mostly indicate that there is a spoofing plot looming.
It’s good to note that even the most vigilant investors can be victims of price manipulation in the bitcoin market. Keep in mind that bitcoin remains a very speculative asset. It may not require more than just the buy low and sell high strategy to make profits and avoid losses through price manipulation.
While the market continues to embrace bitcoin and other altcoins, wash trading and spoofing are some of the practices giving the industry a bad image. Luckily, these practices have grabbed the attention of the authorities and most exchanges are striving to root out the culprits. However, it may take a long time to get the participants in an unregulated market effectively.
Whether you fall victim to such market manipulation practices depends on how you approach bitcoin trading. If you practice the “Hodl” trading strategy, then it’s highly unlikely that such trends will influence your decision. However, traders who make their decisions based on market signals for fear of losing out should be aware that they may be manipulated through spoofing and wash trading.