Spoofing is the manipulation of the bid/ask price (to attract buyers) and offer (to attract sellers) structure on a trading platform to blindfold other investors or traders. The individual or group that carries out the manipulation is called spoofy and has the intention to benefit from the trade. They do not issue place a bid or issue an offer to really trade, rather they do it to press the trigger button of frenzy buying and selling. Such a bid or offer is referred to as the non-bonafide one.
The suspected group of traders concurrently placed a bid and offer on the order book to influence the buying and selling behaviour of traders. Once traders are drawn into the market, Spoofy may then go back to spoof trading. It’s important to note that spoofy have no intention to execute their order. They get it cancelled before someone gets into the deal.
Who faces the brunt of spoofing?
Investors or traders who fail to identify the spoofing attempt fall into the trap allured by rising or dropping prices, and enter or exit a trade. Spoofing is common across all forms of trading such as a stock, commodity, bond, or currency. To your amaze, it’s also a favorite trick of realtors to influence the real estate price and benefit.
Do exchanges have some role in spoofing?
Yes or No. Spoofing is not something that is limited to investors or traders alone. Some exchanges also do it to position themselves as a leading firm with having more market capitalization than their competitors have. They fake the depth of their order book just to drag in buyers and sellers on their platform, which is an unethical trading practice. The next section has a story from the world of crypto trading associated with Bitfinex, a Hong Kong-based exchange.
Spoofing at Bitfinex
Spoofing in the cryptocurrency trading world first came to light in 2017 with the Bitfinex cryptocurrency exchange. The exchange imported order books from other exchanges like Bitstamp to make Bitfinex look larger than what it really was. The ‘Chief Strategy Officer’ of Bitfinex, Phil Potter who used to handle a Bitcoin arbitrage hedge fund (between Bitfinex, and Bitstamp) was allegedly behind the spoofing or order book faking scene.
What could be the probable means to perform spoofing?
Ideally, a spoofy has to keep the amount of crypto asset for the ASK side, and US Dollars for the bid side, and then ‘copy’ the orders from Bitstamp plus any premiums they’d want.
The other easy way is to leverage programming skills. Write a bot in the trading engine that displays the orders without having to invest any real money. This is something that exchanges can do at their best or a hacker.
Where is the risk?
Many would not see any risk to investors or traders when it comes to importing order books from other exchanges. They may argue that this will help them access more trading options, but there is a catch. What if the imported order book has fake entries with orders made by private traders or the exchange themselves. Being unaware of the background, investors would believe what they see and will act accordingly only to risk their money.
Let’s assume that below are the order books from Bitfinex and Bitstamp for Bitcoin (BTC). We’ll analyze the risk factor and loss mathematically. Suppose you want to sell 1100 bitcoin at ASK price USD750. However, you are ready to risk USD50 if the price drop happens while trading.
Looking at the reported Bitfinex Orderbook (650 BTC) and Bitstamp (450 BTC), and the perceived combined liquidity (1,100.00BTC), you make up your mind to sell 650 at Bitfinex and 450 at Bitstamp. However, in reality Bitfinex has buyers only for 200 BTC. Even if on Bitstamp, you get the buyers for all 450 BTC, you managed to sell out only 650 BTC at a minimum of USD700. Citing there is no buyer for the rest of the 450 BTC at the given price, you have no choice but to drop your ASK price. This leads to a loss, also referred to as flash crash.
How to avoid spoofing?
It’s important you trade on a reputed exchange like PCEX Member that does business ethically. It must restrict users with bad intentions from influencing the site and resorting to price manipulation or fake trading. Apply all types of hedging techniques to gain immunity from unprecedented market fall.