7. What is spoofing in the cryptocurrency market?
Spoofing is a technique for manipulating the market. It falsifies its real state. It usually works so that a trader places a fake buy or sell order that will never be executed. Spoofing is used to manipulate the market and the prices of an asset, using various types of algorithms and bots. Of course, this is an illegal activity.
How does spoofing work?
Very simply. As already mentioned, using bots or algorithms, a trader places a fake buy/sell order. When the order is close to execution, the bot or algorithm cancels it. The purpose of this technique is to create false buy/sell pressure; give the illusion of volume, consensus and an active market, and lead the market towards or away from a particular set of prices.
This backfires on the market because there is no clear way to tell if an order is fake. This illegal technique can be effective, for orders placed at moments of support or resistance. As we know, these are key moments for traders.
Does spoofing only occur on the cryptocurrency market?
Spoofing does not only exist in the cryptocurrency market. It is also present, for example, on other financial markets. Consequently,, it can be effectively linked to another asset, which in turn affects the market of another asset, e.g., the USD exchange rate on Bitcoin.
When the market is expecting unexpected movements, then the technique is more effective. If there is FOMO in the market, this leads to high market volatility and therefore false orders can be executed rapidly. On the other hand, if the market is in an uptrend, spoofing is much less effective. However, it all depends on market users and many other factors.
What are the consequences of spoofing?
We mentioned that this technique is illegal in the markets. It also has a very damaging effect on it. Why? Because it causes price changes that are not reflected in supply and demand. At the same time as the fraudsters control price movements, they profit from it.
BONUS – INTERESTING FACTS
- The US Commodity Futures Trading Commission (CFTC) oversees spoofing activities in the stock and commodity markets.
- The Dodd-Frank Act of 2010 regulates the illegality of spoofing.
- The Financial Conduct Authority (FCA) in the UK also oversees this technique.
- In 2018. Bloomberg reported on an investigation that the US Department of Justice (DOJ) has launched to determine whether spoofing manipulated cryptocurrency prices on the Bitcoin network. To conduct the investigation, the DOJ worked with the Commodity Futures Trading Commission (CFTC). The investigation is likely to have focused on Bitcoin not only because it remains the largest digital currency in terms of market capitalization.Also, because its massive price spike in late 2017 pushed hordes of new amateur investors into the cryptocurrency space.
- The UK is imposing sizable fines on traders and institutions responsible for using the technique.
- In December 2020, the US Securities and Exchange Commission (SEC) rejected the Bitcoin Exchange Traded Fund proposal. All due to concerns that the Bitcoin market is susceptible to manipulation.
- The asset market is changing and will therefore be more resistant to such attacks in the future.
- Identifying a spoofing attack is difficult to discover. It requires careful analysis.
- Spoofing should be minimized. Then the investment environment will be sustainable.
- Cryptocurrency regulators often use this market manipulation technique to reject Bitcoin ETFs.
Remember that investing always involves risk, whether you invest in cryptocurrencies or other assets. Caution is the main approach of many experienced traders. If something looks too good, it most typically is. Use reputable exchanges that detect spoofing attempts and respond to them.
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