Numerous manipulative tactics can be observed on the crypto markets every day, aimed to induce price manipulation and intimidate new investors and inexperienced traders. This raises questions regarding which methods are most widespread? And how can they be identified?
Price manipulation is not unique to cryptocurrencies, yet many of these manipulative tactics have been banned by regulators in equity markets. Strict monitoring, reporting, and auditing requirements therefore create risks for those who use them. Further, well-developed mechanisms exist to quickly identify and prosecute wrongdoers. Today, the crypto world is far from that: it is unregulated, anonymous, and individuals or institutions with large holdings, so-called whales, can act with impunity.
In the following, we shed light on three common methods of manipulation in crypto markets:
Pump and Dump
The most common technique in the crypto markets is the initiation of a so-called pump and dump. Here, insiders or other market participants try to drive up the value of a coin until it attracts attention. When a certain price increase is reached, individual investors become aware and want to participate in the price gains. This phenomenon is called «Fear Of Missing Out» or «FOMO» for short. As soon as more investors enter the market, the group dumps the coin at a tidy profit. In the stock markets, this technique has been used with penny stocks, i.e. stocks with a low price. In cryptocurrencies, altcoins with low liquidity are a perfect target. It is impossible to predict the exact timing of a pump and dump. However, there are several signs to identify a potential pump and dump scheme.
Most pump and dumps take place in coins with small market capitalizations that are not included in the top 100 list. Coins with low liquidity are particularly susceptible. Many price movements up and down on just a handful of exchanges are indicative of coordinated action rather than organic market behavior. Another indication is a sudden spread of the coin on social media. If an unknown coin with a market cap of only a few million dollars suddenly appears all over Twitter and Facebook, caution is advised. Finally, trading volume is also a good indicator. The initiators of the pump and dump have probably already amassed a lot of coins. Thus, high volume before a significant price increase, seemingly out of nowhere, is suspicious.
Stop Loss Hunting
Another prevalent tactic is stop-loss hunting, that is, hunting for all visible stop-loss positions. Market participants are forced to exit their positions by driving prices down so far that their stops are triggered. The motivation for the whales is to acquire the assets at a lower price.
Most traders set their stops at key technical levels, which Whales target when stop-loss hunting. An example of this would be a so-called support level, which is a level that the price has «bounced off» of more often in the past when the price is falling. Let's take the price of Ethereum as a hypothetical example. The Ethereum price has increasingly fallen to around $3,600 or $3,700 in December 2021, but has always recovered and risen back to around $4,000 or more. If this exemplary support level of 3,600 US dollars is now reached or breached, countless automated sell orders are executed, with Whales skimming the premium with an almost immediate market rally and more investors following the Whales' buy orders.
With crypto markets active around the clock, unsuspecting traders wake up to the horror of finding that their stops have been reached and triggered. In the meantime, however, prices have already recovered and have reached the level of the previous evening. Since setting stops is still important for risk management when the market is legitimately moving lower, it becomes difficult to detect and completely avoid this technique. One way to mitigate this risk is through so-called stop limit orders. These offer a modest advantage in protecting against larger downside risks, but at the same time leave some room to determine a legitimate exit point.
Many exchanges offer a variety of stop limit orders. It is advisable to analyze whether these are suitable for one's own needs in order to prevent one's own positions from being lost prematurely through such tactics.
Wash Trading
Traders should inform themselves about the trading volume and liquidity of an asset before investing. However, wash trading is used to create the illusion of an active market for a particular asset. It typically involves the simultaneous buying and selling of the same asset by one person, a coordinated group of people, or by a network of bots. A bot being a computer program that performs repetitive tasks largely autonomously without relying on inputs by human users. Hence, wash trading causes a false impression of the actual trading volume on an exchange or on websites such as Coinmarketcap in order to attract new investors and traders. Wash trading can usually be traced back to shady exchanges, fraudulent crypto projects, and individuals who support these projects.
Conclusion
Apart from the listed techniques, there are countless other manipulation scenarios in the field of cryptocurrencies. Therefore, there is nothing better than doing your own research and analysis to draw conclusions and protect yourself from these manipulative techniques. Remember to thoroughly investigate every crypto influencer and investment tip that promotes exchanges or coins.
Please do not hesitate to contact us at cryptoservices@bdo.ch