Not that market manipulation is non-existent in the established legacy financial markets, but it becomes a much bigger issue when you are dealing with an immature industry like cryptocurrencies. Many studies have tried to uncover these abusive practices previously. And this recent one by CryptoCompare nicely outlines some of the most common malpractices that are existent in the space.
Let’s just quickly analyze, why these issues are so abundant in the crypto market. First of all, the immaturity of the industry means even the big-name centralized exchanges are relatively unregulated. A smaller market segment means a low-liquidity environment, which means an attack could have magnified abusive effects. And finally, the lack of implementation of market surveillance solutions leads to less than desired transparency.
For the last one, CryptoCompare’s latest exchange benchmark, 62.4% of assessed exchanges have a market surveillance system in place, of which ONLY 18.1% used an external surveillance solution. Needless to say, this metric needs to improve significantly to tackle market integrity issues. Before we move to the malpractices covered in the report, be advised that this is not an exhaustive list — other types of attacks & hacks also exist.
Wash Trading
This happens when an investor buys and sells simultaneously to artificially inflate the price of the underlying asset. Evidence of this malpractice is found both in centralized and decentralized exchanges. According to CryptoCompare’s report, 23 exchanges have attained a volume-volatility correlation of under 0.1 over the last 100 days. An example of wash trading can be seen in a single exchange (‘Exchange A’ below) — which reported an artificial and/or erroneous volume of $2.5 trillion in August 2022, up from $33.8 billion the month prior.
Spoofing
This technique involves creating fictitious orders by nefarious players — creating and canceling them in quick succession before they can be filled. Spoofing is more prevalent in larger exchanges since manipulators can mask their activity in larger trading volumes. An example of this is given below, where a trader placed an ask order of 20.8 BTC at a price level of $19,036 while BTC was trading at $19,043. Within a minute, the price of BTC fell 0.13% to $19,018. Order book data at 18:48 shows that the ask order was canceled by the trader without being filled.
Front-Running
Inside trading is the most common example of front-running in cryptocurrencies. In conventional stock markets, this practice is strictly prohibited. However, this is much more challenging in digital assets since most of the information is publicly available. In some cases, retail users would be able to use bots to carry out front-running.
by CryptoCompare identified digital wallets of individuals that traded in a manner suggesting access to significant, insider information on exchange listings. A good example of this is a run-up to a token listing on an exchange — excess cumulative abnormal returns (CAR) can be seen in this instance, as highlighted in the chart below.
And finally, is basically a series of spoofs in which several orders are placed along a ladder of progressively higher (layering offers) or lower (layering bids) values. The report winds down by suggesting a series of steps that could be taken to minimize the effect of such market manipulation tactics. Increased data transparency by exchanges, heightened market surveillance & improved regulatory scrutiny could significantly play down these manipulation practices.
