The mechanics of market manipulation

The levers are there to move hundreds of millions in crypto markets, and are clearly labeled

On May 17 of this year, the price of bitcoin suddenly fell. The action began in a single exchange: Bitstamp, based in Luxembourg, where the price in bitcoin dollars suddenly fell more than 18 percent in a matter of minutes. The CoinDesk Bitcoin Price Index, a composite of various market sources, posted a 6 percent drop as a result.

Bitstamp was, at that time, one of the three spot markets used as equal components in the bitcoin price index for BitMEX, an exchange of crypto derivatives based in the Seychelles that operates one of the most liquid bitcoin derivatives markets, perpetual exchange XBT / USD. The other two components of the BitMEX bitcoin index are Coinbase Pro and Kraken. Of the three, the reported volumes of BitStamp are the lowest.

BitStamp price drop was not random. It was caused by a large bitcoin sales order, placed far below the market. The resulting downward pressure caused the automatic liquidation of long positions in the hundreds of millions of dollars in BitMEX. Traders with short positions in the stock market benefited.

In this column, I will provide a visual summary of what happened on May 17 in BitStamp, and a risk / return estimate: if it was manipulation, how much it cost, and how much the handlers earned. I will conclude with thoughts about the liquidity imbalance that caused it and how it could happen again.

Before going into that, I will briefly explain how novel structures and weak markets could make such manipulation possible.

Novel market structures

In the encryption markets, it is normal for investors to interact directly with the exchange, an ethos derived from bitcoin, which invites its users to make transactions with a pseudonym, without intermediaries. In derivative exchanges, accommodating this requires a rethinking of the market structure.

In traditional derivative exchanges, brokers and clearing houses manage the risk of a large price movement breaking a side of an operation. All participants have an incentive to comply with the settlement, so they can re-trade tomorrow. In the exchange of larger crypto derivatives, it is possible to trade directly with an account today and tomorrow. This unrestricted access and pseudonym is part of the history of the rise of these exchanges to become the most liquid markets in cryptography.

To cover the settlement risk, BitMEX and other large crypto derivatives exchange operators use automatic settlement. For example, if the price of the index falls sufficiently below a long open position, the exchange automatically liquidates that position to liquidate the transaction. The surplus of automatic settlements is stored in an insurance fund. If the automatic settlement does not reach an agreement, the insurance fund goes into action. If the allocation of the insurance fund falls short, automatic deleveraging occurs, which unrolls both sides of the operation.

Thin markets

Liquidity is a subjective term, which means the ability of an investor to move a reasonable volume of an asset, without an undue price change. It is related to the depth of the market, measured by the worst price that an order will reach in a certain size limit.

In cryptography, market depth is fragmented between dozens of the largest exchanges and hundreds more in the long tail. Even in the first-order assets of cryptocurrencies, bitcoin and ether, liquidity groups are dispersed, which makes them more superficial. This situation may be getting worse. Bitcoin supply and demand differentials have expanded in most of the largest exchanges in 2019, indicating a decrease in market depth according to a composite data tracker.

The exchanges that are part of the price discovery infrastructure are thin enough for a large order to move the price. And, as we will see below, derivative markets can be much more liquid than spot exchanges that help determine the price of your underlying assets.

What happened on May 17

There is sufficiently explicit information, where you can track a second-by-second account of what happened in the Bitstamp BTC / USD spot market in the early hours of May 17, UTC. Each point is the minimum price or best order offered in the snapshot of each minute of the order book data, which is provided by CoinRoutes. The point size indicates the order quantity.

The action began at 3 a.m. UTC, with a sales order approximately 6 percent below the market price and hundreds of times higher than the standard in the exchange at that time. As that order complied with the offers available, the sale price dropped, dragging the market price down to $ 6,276, at which time the sale was halted. A chronological calculation shows that sellers sold around 2,905.7 bitcoin units, totaling approximately $ 2.5 million below what they would have realized at a bitcoin market price of $ 7,700. At the same time, more than $ 200 million in long positions were settled in BitMEX, according to If it was manipulation, he returned to a multiple of 80X over what the manipulators put at risk. It all ended in about 10 minutes.


The Bitcoin network security model is a fairly simple rational choice theory: miners are rewarded for registering new transactions. To win the reward, they must show that they have compromised something of value, that is, energy. If a miner tries to manipulate the transaction record, other miners are likely to reject the contribution, invalidating the reward. The cost of handling and the probability of failure is balanced with the reward for expected behavior.

Bitcoin programmatically maintains that balance, without resorting to identity verification or trusted third parties. However, the market structure that has evolved around Bitcoin so far has not achieved a similar balance.

It’s not that people haven’t tried to solve the problem: BitMEX reviewed its components of the bitcoin price index in November, adding two new spot markets; Deribit, which currently operates the largest exchange of bitcoin options, domiciled in the Netherlands, has promoted a different way of handling settlements. While deep liquidity funds remain dependent on shallow funds, the structure of the Bitcoin market will be unbalanced, and handlers will have incentives to find ways to avoid these patches.


Disclaimer: This press release is for informational purposes information does not constitute investment advice or an offer to invest. The views expressed in this article are those of the author and do not necessarily represent the views of infocoin, and should not be attributed to, Infocoin.

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