We recently connected with Serhii Zhdanov, CEO at EXMO, a compliant cryptocurrency exchange, registered in the Republic of Lithuania as a “provider of activities of a virtual currency exchange operator and a deposit virtual currency operator” that promotes itself as making investing in crypto easy and “uncreepy.” EXMO’s home page indicates that it provides services to US states where “provision of services without holding a special license is permitted.”
Exmo is a smaller crypto exchange. According to its website, the marketplace has over 24,000 active daily traders, about 180 trading pairs, an exchange token EXMO Coin (EXM) and operates with 6+ fiat currencies. The average daily trading volume is over $200 million.
Serhii Zhdanov claims to have a wide breadth of experience in the cryptocurrency, Fintech, and financial industries. Serhii shared insights on the impact of market manipulation in cryptocurrency; the importance of compliance and regulation in cryptocurrency; enhancing security in a crypto exchange; market volatility and crypto investor behavior.
Our conversation is shared below.
Crowdfund Insider: What is market manipulation in cryptocurrency?
Serhii Zhdanov: Market manipulation refers to artificial inflation or deflation of the price of a crypto asset. In the crypto world, market manipulation is typically facilitated by 1) lack of regulation and 2) flaws in blockchain’s decentralization architecture.
In the crypto-sphere we see mostly the same classic methods of manipulation known on traditional financial markets, such as spreading false or misleading information about the projects or companies behind certain coins, or using a series of transactions to boost a coin’s volume so it appears more actively traded.
As the cryptocurrency market is less regulated than traditional financial markets, many market manipulation behaviors are not yet prohibited by local regulators. Therefore, investors, especially retail investors with limited funds and information, are often exposed to risks associated with market manipulation.
The other factor that contributes to crypto market manipulation is the innate flaws of the blockchain technology. Although blockchain facilitates the so-called decentralized finance, which can ideally speed up transactions and reduce costs by eliminating third parties, the technologies are not yet mature enough to construct a robust decentralized architecture for the market.
While companies and scientists have been working hard to strengthen their chains, experienced hackers can often find holes to exploit. Therefore, many cryptocurrencies are vulnerable to manipulation due to their underlying technical deficits.
Crowdfund Insider: Compared with spot trading, why do derivative contracts facilitate market manipulation?
Serhii Zhdanov: Derivatives, or contracts for the supply of specific underlying assets in the future, reflect the expectations of market players regarding the price movement of the asset. At the same time, the data on open positions becomes an analytics tool for making further trading decisions. Therefore, many investors rely on derivative prices to read the market and make investment decisions.
However, derivative contracts are not always telling the truth about demand and supply. Actually, they facilitate market manipulation because there are points in time, where a manipulator can find periods of lower liquidity on derivative contracts and start to build a price trend from there. Why does liquidity matter? Like in the stock markets, lower liquidity means you can use less money to impose influence on prices, so that makes manipulation easier than in highly liquid times.
Like what we’ve seen in traditional financial markets, derivatives are one of the most popular and effective tools for risk hedging. In the crypto world, big players like funds use various types of derivative contracts to hedge their positions, explore opportunities, or make risky plays. All these extend a significant psychological influence on the market, and can really confuse investors who has no insider information on the price changes. As a result, the market typically follows big players and people start to chase the underlying price.
Crowdfund Insider: How does a trader manipulate crypto prices with derivative contracts? Maybe use an example to clarify.
Spot and Futures Example:
Assume BTC currently trades at $30,000, while the one-month futures contract is priced at $35,000. In addition, monthly carrying costs for this asset amount to $5,000. In this case, there is no benefit in holding spot bitcoin and short one-month futures because either option costs the same.
However, once a manipulator moves the futures price to, let’s say 40,000$, here’s an opportunity to profit: buy spot bitcoin at $30,000 and at the same time, sell one-month futures contracts to get $40,000. Hold the bitcoin for a month at the cost of $5,000, and deliver it at the end of the month to close the futures contract. This way, the net profit is $40,000-$30,000-$5,000=$5,000.
Spot and Option Example:
If we consider options with physical settlement – on expiration day, a big player can manipulate the price of the option so that the option with the highest open interest expires worthless, thereby generating a cascade of margin calls and a rally in the spot market as people rush to buyback bitcoin to stake it on the contract.
While this type of manipulation can probably be noticed by market veterans, note that broker margin calls as well as many trading accounts are managed by algorithms that are triggered by numbers. Once a significant price change happens, the quick reaction of trading robots can immediately lead to a market earthquake – everything is programmed to happen in seconds, and there’s this ripple effect boosted by people’s greed and fear.
Crowdfund Insider: What happens if a cryptocurrency is being manipulated?
Serhii Zhdanov: If it’s a popular cryptocurrency: The coin has good liquidity due to its popularity. In the event of manipulation, there will be a price difference between exchanges, which can sometimes be very significant, and therefore creates arbitrage opportunities. Then, arbitrageurs will start to get profit from arbitrage, which eventually brings the price to back its fair level and therefore, nullifies the whole effect of manipulations over a long time period.
If it is an unpopular cryptocurrency in an illiquid market: As usual, manipulators are the winners, and those manipulated are the losers. Generally, the trading on the manipulated cryptocurrency will begin to follow the “Pump & Dump” scheme and after a dump, the price starts to move lower pre-pump level.
Crowdfund Insider: How does market manipulation impact the exchange?
Serhii Zhdanov: When manipulation happens, the reputation of the exchange where it takes place will be damaged as it fails to protect its customers by creating more liquidity against the manipulation-related transactions. As a result, customers may no longer trust this exchange, and eventually transfer their assets to other exchanges.
That being said, when the asset being manipulated is available on many different platforms, it will have better liquidity and therefore makes manipulation much harder. In this case, even if a manipulator manages to inflate or deflate a coin’s price at an exchange, that effect will not last long, and the exchange will be less severely harmed in terms of reputation.
Crowdfund Insider: How does market manipulation impact other investors?
Serhii Zhdanov: In general, investors lose money in a manipulated market. But by setting certain price alerts, during the inflation phase, investors can probably sell their crypto at a good price or perform arbitrage when there’s a chance.
Also, similar to investing in undervalued stocks, if an investor believes in the long-term development and price appreciation of a project whose cryptocurrency price has just fallen significantly, then he or she can deploy the dollar-cost averaging strategy to buy that coin at a good price and just hold it for a long time. In other words, the investor can keep investing a fixed dollar amount regularly over months or years, regardless of the price, and wait for the price to rise back to a desired level.
Crowdfund Insider: How does market manipulation impact the company/project behind that cryptocurrency?
Serhii Zhdanov: Often, manipulations are done by the company behind that cryptocurrency, so that management can sell their coins at a good price. Naturally, it has a negative effect, as investors will soon realize that the price of the coin is not backed by solid business performance, but shady behaviors like price manipulation.
Nowadays you can also watch side attacks on asset price, especially if it’s a prominent project. In this case, the manipulation effect can vanish with time, but can destroy a weak project.