For many years, traders have used different tactics, including bluffs, to predict and benefit from market movements. In the past, they would stand face to face on trading floors, using hand gestures to buy and sell assets. However, in today’s digital world, traders can monitor market trends from the comfort of their screens, whether on mobile phones or computers.
As trading methods have evolved with technology, so too have fraudulent techniques. Scammers now use computer trading software and algorithms to flood the market with fake orders to make a profit. One such tactic used to manipulate the market and push others to buy or sell quickly to benefit from price changes is called spoofing. Below, we’ll explain what spoofing is and how it works, whether in stock markets or cryptocurrency.
What Is Spoofing?
Spoofing is a type of market manipulation where traders place large buy or sell orders on one side of the market, which exceeds the best available bid or offer. This large order gives the illusion that the market is shifting, encouraging other participants to buy or sell their assets.
However, this large order is not real and is canceled once the manipulation has worked. The spoofer plays both sides of the market, placing two orders: one large, fake order that is canceled after the market reacts, and a second, real order on the opposite side that gets executed when the market reaches the desired price.
Spoofing happens when traders place a large number of buy or sell orders for a financial asset, such as stocks, futures, or cryptocurrencies, without any real intention of following through. The purpose is to artificially inflate or deflate the demand, creating opportunities to make a profit. This deceptive tactic tricks other market participants into believing there’s a shift in market pressure and makes them respond by placing orders at manipulated prices.
Spoofing impacts prices because it creates a false sense of movement in the market, leading other traders to act on these artificial price swings. Spoofers often rely on algorithmic trading systems to help them achieve this goal.
What Is Algorithmic Trading?
Spoofing is possible because of algorithmic trading and high-frequency trading (HFT). Algorithmic trading uses computer programs that follow specific instructions, or algorithms, to make trades and financial decisions quickly. These programs scan financial markets in milliseconds to place and execute orders faster than any human could. This gives a significant advantage to traders using this method.
High-frequency traders (HFT) use algorithmic trading to make large numbers of transactions in a very short amount of time. They use the best software to carry out these trades at lightning speed.
While high-frequency and algorithmic trading are not illegal on their own, they can be misused for fraudulent activities like spoofing. Professional traders in markets like stocks, crypto, and futures use these methods regularly to predict price movements and increase profits. Major exchanges like the Chicago Board of Trade, New York Mercantile Exchange, and Chicago Mercantile Exchange often rely on these strategies.
However, when these methods are used to manipulate the market, it crosses the line into illegal activity, like spoofing. Let’s explore how spoofing is treated under the law and how it differs from legitimate high-frequency trading.
Spoofing Regulations and Enforcement Actions
Spoofing is illegal under the Dodd-Frank Act of 2010, which defines it as “the illegal practice of bidding or offering with the intent to cancel the bid or offer before execution.” Spoofing is often used alongside other illegal tactics like layering algorithms and front-running.
In the United States, spoofing is monitored and regulated by the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). However, detecting spoofing can be tricky, especially in futures markets, where bids are regularly canceled. Regulators typically track suspicious activity over time before imposing fines, criminal charges, or conducting investigations.
Criminal and Civil Cases
Several high-profile cases illustrate how spoofing is treated as a criminal activity. Here are some notable examples:
- Michael Coscia, an American trader, was charged in 2013 for using algorithmic trading software to manipulate futures markets through spoofing. He paid $2.8 million in penalties to resolve civil charges brought by the CFTC. Later, the U.S. Department of Justice filed criminal charges, alleging that Coscia earned over $1.5 million from spoofing.
- The CME Group Inc., a market exchange company, penalized Igor Oystacher from Chicago with a $150,000 fine in 2014 for engaging in spoofing. Oystacher was also barred from trading for one month.
- Navinder Singh Sarao, a day trader from London, was charged with spoofing and market manipulation in connection with the 2010 flash crash, which caused stock prices to plummet. Sarao manipulated E-Mini S&P 500 futures contracts by placing large orders with no intention of completing them.
- In 2018, the CFTC fined three European banks—UBS, Deutsche Bank, and HSBC—a total of $47 million for engaging in market manipulation and spoofing.
Spoofing and Cryptocurrency Markets
In recent years, spoofing has also become more visible in cryptocurrency markets. While the CFTC mainly monitors traditional markets, the crypto community was the first to raise concerns about spoofing on crypto platforms. Let’s explore some notable incidents of spoofing in cryptocurrency trading.
The Case of “Spoofy” in Cryptocurrency Markets
One of the first major allegations of spoofing in crypto markets came from a blog post titled “Meet Spoofy: How a Single Entity Dominates the Price of Bitcoin.” The post described how a mysterious trader, referred to as Spoofy, manipulated Bitcoin prices on the Bitfinex exchange by placing large buy orders to raise Bitcoin’s value and then selling assets at higher prices.
This blog post sparked widespread interest and was later investigated by Bloomberg News. The allegations suggested that Tether, a stablecoin tied to the US dollar, was being used to manipulate Bitcoin prices on Bitfinex, which shares the same parent company as Tether.
How Tether and Bitfinex Allegedly Manipulated Prices
Tether is a stablecoin that should always be worth 1 US dollar, backed by actual US dollars held by the issuing company. However, concerns about the legitimacy of Tether’s reserves arose in 2018, leading to investigations by regulators.
A forensic study claimed that large amounts of Tether were used to artificially boost Bitcoin’s price. Bloomberg News also investigated and found potential spoofing patterns on the Kraken exchange, where Tether’s price movements raised concerns.
The Tether Saga
Tether was launched in 2014, but its relationship with Bitfinex wasn’t fully revealed until the 2017 Paradise Papers leak. In 2021, Tether faced significant legal challenges, including a $41 million fine from the CFTC for falsely claiming to have reserves backing its stablecoin. Financial authorities continue to monitor Tether closely because of its influence on the overall cryptocurrency market.
Final Thoughts
Spoofing and wash trading are market manipulation strategies used to create artificial price bubbles. Spoofers manipulate prices by tricking other traders into buying or selling in a frenzy. Although spoofing affects all markets, the cryptocurrency market is particularly vulnerable due to the “fear of missing out” (FOMO) effect.
While traditional markets have long been regulated to prevent spoofing, cryptocurrency markets have remained largely unregulated, allowing bad actors to take advantage of traders. However, as financial authorities continue to tighten regulations, spoofing in crypto markets may soon face stronger enforcement.
