From pump and dump schemes to wash trading, the crypto market has been a favored target for fraudsters and malign traders.
In fact, a study conducted by TheTie last year estimates that over 86% of the total reported Bitcoin exchange volume was suspicious, with 75% of crypto exchanges reporting “extremely dubious” volumes in early 2019.
As the crypto industry is still young and only partly regulated, it’s extra susceptible to market manipulation.
Market surveillance solutions can help organizations in the space combat such practices.
These solutions are increasingly available to the crypto market, and major industry players are progressively adopting market surveillance strategies to protect their investors.
- Due to the immaturity of the crypto market as well as the lack of regulation, digital assets are highly targeted by market manipulation.
- Market surveillance is a proven strategy to combat fraud and price manipulation.
- Market surveillance tools monitor trades for common market manipulation tactics on crypto exchange platforms, alerting the operator in case suspicions arise
- With market surveillance, crypto exchanges can ensure that their platforms are free from fraudulent activities and better able to market participants and foster confidence.
What Is Market Surveillance?
Simply put, market surveillance is a practice to prevent and investigate manipulative, abusive, or illegal trading activity.
Market surveillance is widely used in global markets by organizations in both the private and public sectors to ensure orderly markets.
As a result, market surveillance encourages buyers and sellers to participate in the market, as preventing and eliminating price fraud instills trust.
Without actively screening for fraudulent activity, markets can easily become disorderly, posing additional risk – this hinders growth.
It’s no different in traditional finance. Let’s say you’re seeking to purchase the shares of a promising company that is listed on a particular stock exchange.
Despite the company’s great potential, you may be discouraged from moving forward with your investment after discovering that the exchange is swarmed with fraud, price manipulation, and other illegal schemes related to stock-trading activity.
As you are not sure that the stocks of your selected company are affected by these activities, you decide to register an account with a reputable broker in a country where the securities market is under tight regulatory scrutiny.
As trading platforms have to comply with regulatory measures – such as Know-Your-Customer (KYC) and Anti-Money Laundering (AML) rules –, market surveillance helps them in complying with regulation.
Because of the same reason, market surveillance is a common practice among trading platforms on the general market, with numerous big names offering solutions to prevent security-related fraud.
For example, the NASDAQ SMARTS Trade Surveillance is a popular tool that actively monitors trading activity at over 160 organizations in traditional finance to combat fraudulent activity.
Price Manipulation and Fake Trading Volumes
Like other markets, or any lucrative business for that matter, the crypto industry is a common target for malicious practices. However, as digital assets are relatively new, it is more complicated to compare prices as well as assess transaction and volume data.
Furthermore, as cryptocurrencies are more volatile and less liquid than general market assets, they are more susceptible to price manipulation schemes.
Unlike on the traditional market where fairness and transparency are a requirement, in crypto it’s up to the exchange operators to self-regulate. But this recognition is only slowly dawning on operators.
As mentioned, TheTie’s research revealed that the majority of the Bitcoin volumes are suspicious, with a great number of crypto exchanges reporting shady trading volumes in early 2019.
Later on, more research firms published similar reports, confirming that the majority of exchange volumes were fake.
Bitwise – that published its whitepaper on the US Securities and Exchange Commission’s (SEC) website – cited even worse statistics, alleging that 95% of the total Bitcoin trading volume reported by unregulated exchanges were fake or non-economic at the time.
The real problem with dishonest exchange volumes is that they could falsely indicate that a crypto trading platform is more liquid than the competition, attracting traders who perceive that the service could better satisfy their needs than other market players.
Also, if the trading volume of a cryptocurrency is driven by artificial growth, it could wrongly give investors the idea that the asset is seeing adoption and skew their view on the asset’s price.
The Most Common Crypto Price Manipulation Schemes
Fraudsters and dishonest trading platforms tend to use the following tactics to manipulate cryptocurrency prices:
- Pump and dump schemes: Cybercriminals usually target coins with lower market capitalizations and limited liquidity with pump and dump schemes. The fraudsters here choose a digital asset then increase its price artificially by pouring large amounts of funds into it. As a result of the massive purchase, the coin’s price will increase significantly. Other investors will buy the asset in the hope of more growth. After realizing a profit, the cybercriminals will sell their digital asset at once, leaving genuine investors with a worthless coin.
- Wash trading: Wash trading is a price manipulation tactic where a fraudster simultaneously buys and sells an asset without a change in beneficial ownership or market risk. As a result of these fictitious transactions, the price of the asset can be manipulated. By indicating a false price trend, investors may decide to purchase or short the asset.
- Spoofing: In a spoofing scenario, a cybercriminal places a large number of trades and quickly cancels them before they are executed. As a result, the price spreads are altered, and the executed transactions on the opposite side of the market will follow the actions of the fraudster, increasing or decreasing Bitcoin’s price.
- Layering: The goal of the layering strategy is to artificially increase or decrease the price of a crypto asset by placing orders to enhance the order book without intending to execute them.
- Ramping: Fraudsters utilizing the ramping tactic execute a massive number of transactions in short periods of time to manipulate the market price.
How Can Market Surveillance Combat Crypto Fraud?
Cybercriminals and dishonest service providers take advantage of the industry’s lack of proper regulatory oversight to manipulate digital asset prices.
Fortunately, multiple market surveillance solutions have been developed with a particular focus on crypto markets.
Based on information on common tactics to manipulate crypto markets, these automated solutions leverage machine learning and artificial intelligence to actively screen the transactions on trading platforms and improve responsiveness as these markets continue to grow.
When the market surveillance tool detects suspicious activity in the order book, it alerts the exchange platform in real-time.
With the help of market surveillance tools, crypto exchanges are able to effectively combat market fraud and manipulation.
As a result, they are able to protect their investors, safeguard integrity, and foster investor confidence.
AAX Takes Market Integrity Serious
AAX is the world’s first digital asset exchange to be powered by LSEG Technology. Offering OTC, spot, and futures, it provides a highly secure, deeply liquid and ultra-low latency trading environment; and a meeting point between crypto and global finance.
Market integrity is among the core principles at AAX, along with high performance and security. As more and more exchanges submit their markets to regulatory scrutiny and adopt market surveillance technology, the crypto markets will become more attractive to institutional investors, and this is crucial to serious growth.