Crypto “bot” trading hurting market reputation and individual investors

Report: Crypto trading ‘bots’ caught arbitraging investors by front running

Crypto press headlines typically focus on the dark side of exchange compromises and the billions in dollars of losses that must be absorbed by the firms and their customers. There is, however, a more sinister threat lurking in the shadows that is seldom discussed, but which could prevent the massive adoption that crypto zealots hope will come to pass. Crypto “bot” trading is the issue and the havoc it is presently wreaking upon the under-regulated crypto market each and every day.

For the uninformed, trading robots are not something new, nor will they overtake the world by way of some Terminator inspired Skynet conspiracy. Automated algorithmic trading hit Wall Street several decades ago. The math and programming geniuses behind this phenomenon were soon called “Quants”, and they also very quickly enriched themselves and their firms with trading profits. All major banks and hedge funds now release their automated trading routines, now driven by Artificial Intelligence and Machine Learning technology, each day and allow them to adapt to market conditions.

This form of high-speed trading often draws criticism, sometimes causing “flash crashes”, but as long as the methods stay within legal boundaries, the market benefits from greater liquidity and tighter Bid/Ask spreads. The “legal boundaries” have been defined by regulators and generally have to do with processes that are deliberate attempts at price manipulation.

Jay Clayton, the Chairman of the SEC, has spoken often about concerns in the crypto space that make him feel uncomfortable. He has denied Bitcoin ETF applications on many occasions, noting that:

What investors expect is that trading in the commodity that underlies that ETF makes sense and is free from the risk of manipulation. It’s an issue that needs to be addressed before I would be comfortable. Those kinds of safeguards do not exist currently in all of the exchange venues where digital currencies trade.

Abusive practices that are outlawed on regulated exchanges are “wash trading” and “spoofing”, each designed “to make money at the expense of the ‘honest’ trader”. In a wash trade, items are sold at a loss, but quickly bought back at the same price, thereby creating the illusion of major activity and volumes, a common device in a pump-and-dump scam. Spoofing involves creating fake orders to drive buy or sell volumes for similar reasons. Monitoring software is used to ferret out these illegal practices.

In last December, the Blockchain Transparency Institute (BTI) published its detailed analyses, using newly developed and tested algorithms to detect wash trading. The headline sent chills down the spines of every crypto exchange executive in the industry: “Over 80% Of The Top 25 BTC Pairs On Coinmarketcap Is Wash Traded.” The report further disclosed that:

Most of these pairs have an actual volume of less than 1% of the volume reported on Coinmarketcap. Of the top 25 BTC pairs crypto exchanges, only 2 were discovered not to be wash trading their volume: Binance and Bitfinex.

The sad part of this story is that many exchanges in the system actually encourage the use of these illicit automated trading robots, putting them knowingly at the disposal of their customers. The exchange market can be extremely competitive on the local level, and the yardstick that influences investor choice the most is how an exchange ranks in daily trading volume. Exchanges like to pump their volumes, but the new report has already led to court action. A judge in South Korea recently sentenced two exchange executives to hefty jail sentences for wash trading and illicit profit gains.

James West, a noted writer on crypto matters such as these, recently wrote:

The damage wrought upon the overall direction of the crypto industry by these short-term profit-chasers is truly massive. They de-legitimize the very mechanisms responsible for crypto asset price-discovery, compromising the integrity of the market and prompting regulators to squarely deny ETF proposals, citing these issues.

News today is that the CBOE withdrew its latest application for a Bitcoin ETF, the one item that crypto supporters believe with bring legitimacy to the crypto ecosphere. In order for new submissions to occur, price manipulation techniques must be banned, either by self-regulation or by the actions of regulators in every jurisdiction. Until then, mass adoption of cyrptocurrencies by the public and institutions will remain an illusive goal.

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