With the recent rise of popularity in investing in cryptocurrency, I wanted to write a post about the dangers the lack of regulations in an exchange.
While we are seeing a move by the world governments to start to identify crypto-trading as an investment (thereby demanding folks pay a capital gains tax on your profit), we have yet to see governing authories (at least in the US) start to crack down on the exchanges (and ICOs) with regulations.
Brief History of Regulation
Prior to the infamous Black Tuesday, the only laws in place to protect investors from worthless securities were on the state level and were known as the blue sky law. The first blue sky law was enacted in Kasas in 1911 and quickly expaned into 47 states by 1933. These state securitie laws were named for the evil at which the law aimed such as "speculative schemes which have no more basis than so many feet of 'blue sky.'" These laws required companies to disclose how much interest they were getting but didn't stop the investors from buying (as long as they were "informed"). Further, these blue sky laws were ignored when companies were making securities offering across state lines.
In response to the Great Depression, we see FDR's New Deal enacted. Congress passes the Securities Act of 1933 which regulates the interstate sales of securities at the federal level. A year later, with the passage of the Securities Exchange Act of 1934, the Securities and Exchange Commision is created to enforce the federal securities laws.
Since the 1930's, Congress has continued to empower the SEC hoping to make the market a safer place for an individual investor.
Examples of market manipulation
Here is a list of examples of market manipulation you will see in any typical crypto exchange. As you can tell from the examples below, it is incredibly hard to prove the intent behind these manipulation, but at lest you'll have a frame of reference when you see a flurry of activities in the market place.
Wash Trades — where you trade with yourself, to pump the price up or down, or just create the illusion of trading volume. You could literally do this in the Bitfinex trading engine quite recently.
Spoofing — where you place a large order to create the illusion of market optimism or pessimism, and cancel as soon as the price gets anywhere near it. This can be seen quite often on Bitfinex and Coinbase/GDAX.
Painting the Tape — like wash trading, but with two or more participants. Mark Karpelès admitted in court that he had been using the “Willybot” to pump up the Bitcoin price on the Mt. Gox exchange during the 2013 Bitcoin bubble.
Front-Running — where a market participant takes advantage of a buy or sell order before other customers can. Typically folks in high-frequency trading get a lot of heat for this but it's improbable outside folks in crypto are taking advantage of the markets. Instead we are seeing insiders with access to the database trading on their own exchange — Bitfinex officers trade on the exchange themselves. They state that they avoid conflicts of interest, but there is no oversight or transparency on this.
Pump and Dump / Trash and Cash - where a group of market participants artificially increase/decrease the price through rumors. We see this quite often in a variety of alt-coins where there are no significant announcements/news and yet the prices go up 200-300% and drop as quickly in a day or two. I have read (but not confirmed) there are discords channels out there for this specific purpose.
Quote Stuffing - flooding the market with large quantities of orders and gaining an advantage over slower market participants
Now that you know of these manipulations, just be wary of them. These won't stop until there are more regulation (or people start boycotting one exchange over another) and I don't see that happening in the near future. At least now you are aware and can stay safe while trading!
Edit: I just came across this article that also talks about price manipulations in Bitcoin when Mt. Gox was still alive.
Edit2: Also, this is a great article of finding a bot that painted the tape.