08. February 2023

How bots manipulate the prices of cryptocurrencies


This year, the cryptocurrency market has grown exponentially, with a market capitalization of $440 billion at the time of writing. Bitcoin is the largest cryptocurrency, with a year-to-date increase of 1,500 percent and a daily notional value of pancakeswap sniper bot over $10 billion. How much of this trading, if any, can be attributed to actual human buyers, versus how much is automated?


As it turns out, bots may constitute a significant portion of short-term holdings. Worse, bot trading may be unrestrictedly manipulating the market, artificially inflating prices, and causing individual investors to overpay for their executed trades.


What are bots?

A bot is an automated trader that buys and sells on the short-term market automatically. Due to the fact that robots are preprogrammed to buy and sell without emotion in response to specific triggers, they are historically responsible for dramatic market crashes. The infamous 1987 Black Friday Wall Street crash, in which equities fell more than 30 percent in a single day, was caused by program trading — the first generation of robots that sold stocks automatically when their price fell below a certain threshold.


Today, bots are ubiquitous and are no longer restricted to the stock market. In the world of equities, some robots (commonly referred to as high frequency traders) are welcomed because they provide liquidity to ordinary buyers and sellers. In the world of cryptocurrencies, however, not all bots are created equal, and many are not designed to assist you.


Bots and cryptocurrency: a match made in heaven


Much more sophisticated bots than those that precipitated the 1987 stock market crash infiltrated cryptocurrency almost immediately after it gained traction. Individuals with programming skills are now prevalent across all cryptocurrency exchanges in order to take advantage of an advantageous situation: an exploding market, an influx of relatively inexperienced investors seeking to capitalize on that market, and a lack of government regulation.

Neo is a case in point. As a result of Ethereum’s 5,800 percent increase in 2017, investors flocked to Neo, the Chinese equivalent of Ethereum. And Neo quickly became an ideal environment for a trading bot to exploit overly optimistic and inexperienced investors. Advanced crypto trading platforms began detecting anomalous signals on November 29 that indicated multiple bots trading on Neo. The extreme volatility of the market and the simultaneous trading of dozens of bots caused the price to plummet within minutes of the first detected signals. In a matter of seconds, Neo went from $34 to $3.74, before returning to $34. Investors who wagered heavily lost nearly everything in the blink of an eye. This type of flash-crash has occurred before and will likely occur again.


In other instances, bots can manipulate cryptocurrency markets by inflating prices artificially. Their automated trading behavior causes them to overpay for the coins they purchase on cryptomarkets. The “pump-and-dump” scheme that was popular in the early 1990s and made famous by Jordan Belfort in The Wolf of Wall Street is still being run effectively — by bots — in today’s cryptocurrency markets. This scheme involves the coordinated purchase of low-priced coins in order to “inflate” the price and attract new investors who are easily excited by price increases. As investors buy “the pump” unknowingly, bots sell the asset in near-perfect coordination. With no new buyers entering the market, the coin rapidly loses value, leaving investors scratching their heads and wringing their hands over their wallets.


Unfortunately, this situation occurs far too frequently on cryptocurrency markets. According to Business Insider, there is no shortage of coordinated schemes in which a group of traders use bots to purchase coins simultaneously in order to drive up the price. Investors hear about the coin, become swept up in the euphoria surrounding it, and purchase it in hopes of making a quick profit. What is left for them is anything but.


It is likely that more people will be susceptible to pump-and-dump schemes as the number of “retail” investors entering the crypto space has increased in recent weeks in pursuit of Bitcoin’s boom.


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