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  • The manipulation of crypto assets
Article:

The manipulation of crypto assets

19 April 2022

6 min

Market manipulation is the attempt to artificially influence the price of an asset or the behavior of the market. As a rule, this is an individual or a group that tries to create an illusion in the market in order to profit from the consequences. Many of these manipulative tactics have been banned in stock markets by regulators. Strict monitoring, reporting and auditing requirements therefore create risks for those who apply them. Furthermore, there are well-developed mechanisms to quickly identify and prosecute offenders.

The crypto world today is far from the fact that there is no market manipulation: it is unregulated, anonymous, and people or institutions with large stocks, so-called whales, can trade with impunity. On a daily basis, numerous manipulative tactics can be observed that are aimed at price manipulation and panic new investors or inexperienced traders. Which methods are most common? And how can these be recognized? We take a look at three common methods of manipulation in crypto markets.

Pump and Dump

The most common technique on the crypto markets is the initiation of a so-called pump and dump. Insiders or other market participants try to drive up the value of a coin until it attracts attention. If a certain price increase is achieved, 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 other investors enter the market, the group sells the coin with a decent profit. In the stock markets, this technique was used for penny stocks, i.e. stocks with a low price value. In the field of cryptocurrencies, altcoins with low liquidity are a perfect target. An example:

The "Squid Game" coin got its name from the popular Netflix series and has been tradable since October 26, 2021, the starting price was around 0.124 euros. On November 1, 2021, at 10:25 a.m., the price peaked at 543.06 euros — a profit of over 400,000%. 15 minutes (!) later, the price was again around 0.002 euros.

It is impossible to predict the exact timing of a pump and dump. The developers behind these tokens, which increasingly include so-called meme coins, are making every effort to make their project appear legitimate. This is also the case with the Baby Musk Coin, named after Elon Musk, who lost almost 100% of its value within a few minutes on February 9, 2022. The project raised over $2 million during its Initial Coin Offering (ICO), which took place in early February 2022.

However, there are various signs to recognize a possible pump-and-dump scheme. Most pump and dumps take place on small-cap coins that are not in the top 100 list. Coins with low liquidity are particularly vulnerable. Many price movements up and down on only a handful of exchanges are an indication that it is a coordinated action rather than organic market behavior. Another indication is a sudden spread of the coin on social media. Every day, new cryptocurrencies are being created that try to pick up on the zeitgeist and generate hype. If an unknown coin with a market cap of just a few million dollars suddenly appears everywhere on Twitter and Facebook, caution is advised. Finally, trading volume is also a good indicator. The initiators of the pump and dump have probably already accumulated a lot of coins. A high volume before a significant price increase that appears seemingly out of nowhere is suspicious.

Stop-Loss Hunting

Stop losses are automatic orders to sell a cryptocurrency when it falls to a certain level. They are placed on a trading platform and can be left open for a day (daily order) or forever (good until execution). If market participants are to be forced to exit their positions, this is referred to as stop-loss hunting, i.e. the hunt for all visible stop-loss positions.

The hunters in this scenario could be whales, brokers, mining pools or large institutions. The hunted, mostly individual investors and traders, are to be forced to exit their positions by driving prices down so far that their stops are triggered. The motivation for the hunters is to acquire the asset at a lower price.

Most traders set their stops at important technical or psychological levels or levels that whales target in stop-loss hunting. It is easier for people to divide their gains/losses based on round numbers. Therefore, at any psychological level, there are probably a large number of stops that are just below that level. As a hypothetical example, let's take the price of Ethereum. It can be assumed that there are a lot of stop-loss positions at or just below the $3,000 mark. Other important levels are so-called support levels, i.e. a level from which the price has increasingly "bounced" in the past when the price falls. The Ethereum price has fallen in December 2021 increasingly to about 3,600 or 3,700 US dollars, but has recovered again and again and has risen again to about 4,000 US dollars or more. If this exemplary support level of 3,600 US dollars is now reached or undercut, countless automated sell orders are executed, with Whales siphoning off the premium with an almost immediate market recovery and other investors following the buy orders of the Whales.

With crypto markets active around the clock, unsuspecting traders wake up and find with horror 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 downwards, it becomes difficult to detect and completely avoid this technique. One way to do this is through so-called stop-limit orders. These offer a modest advantage to protect against greater downside risks, but at the same time leave some leeway 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 your own needs in order to prevent your own positions from being lost early through such tactics.
 

Wash Trading

Wash trading usually means the simultaneous buying and selling of the same asset by a person, a coordinated group of people, or by a network of bots, a computer program that performs repetitive tasks largely automatically without having to interact with a human user. Most traders learn about the trading volume and liquidity of an asset before investing. Wash trading is used to create the illusion of an active market for a particular asset. This gives a false impression of the actual trading volume on an exchange or on sites like 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. Also in the area of non-fungible tokens (NFTs), sellers are driving up the value of digital assets through a series of fake sales between related parties. Buyers end up paying too high a price.
 

Verdict

Investing in cryptocurrencies, like any other investment, comes with risks. In addition to the aforementioned techniques, there are countless other manipulation scenarios in the field of crypto currencies. However, the more regulations are introduced, the more difficult it will be to manipulate the market. And even as more and more crypto exchanges try to put a stop to market manipulators, knowing how to recognize and avoid common tactics is an important tool for any individual trader and investor. Especially because professional market manipulators do everything not to be discovered.

There is nothing better than your own research and analysis to draw conclusions and protect yourself from manipulative techniques. Investors are well advised to check every crypto influencer and every investment tip that advertises exchanges or coins.

Disclaimer: This article was also published in Private Magazine, Issue 01/2022,

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