Unless you've been living under a rock in the crypto world, you're probably well aware of the fact that in recent weeks Big Money has started to take an official hand in the Bitcoin and Altcoin revolution. Both CBOE and CME have entered the market with BTC trading contracts.
This means that people with significant means (i.e. The Rich / The One Percent) can now enter into short positions on BTC. Over the last two weeks, I've been hearing people say that this is a good thing for cryptocurrency, and I believe it will be in the long run if you just hold your coins.
In the short term though, there's likely to be quite a bit of market manipulation happening. Like today. These people are sophisticated investors with loads and loads of experience at manipulating markets, and huge piles of money with which to do so. Combine that with the fact that the crypto markets aren't regulated like the NYSE or NASDAQ, and they end up with a field full of cash trees that are ripe for harvest.
One of the unique things about the entire cryptosphere is that it's largely been made up of inexperienced investors to date. These are people who saw the opportunity, got in early when the risk level was still very high, and have benefited greatly from the subsequent rise.
One thing can be said about them as a group though. By and large they lack experience in dealing with market manipulation tactics. I thought I'd take a second to explain what I see happening today in the cryptosphere so that when it happens again – and it will! - perhaps some of the less seasoned investors will be better prepared.
I'll approach this from the standpoint of one of the Rich, so that you can see what it looks like from their perspective. Along the way you'll understand how a LOT of money was transferred today from the middle class to the one percenters. Before anyone gets their panties in a bunch, yes, I'm well aware of the fact that there are errors in the following scenario. It's impossible to know the exact math, and I'm just trying to paint an overall picture so that people understand market manipulation.
Let's say that you have a group of investor friends, and that the sum of your liquid assets is somewhere north of one hundred billion dollars. Trust me, they're out there.
CME, a long time investment partner that you've used for years, comes along and offers you short contracts on BTC. This offers you several opportunities.
Let's say you want to put 25 billion USD into the BTC market, but you don't want to do it at the top of a BTC spike that is approaching $20,000. What can you do? First, you can allocate several billion dollars to BTC futures contracts on a short position. In other words, you're agreeing to sell BTC at some future date for a lower price than it is currently at today. There are plenty of bullish BTC folks out there who are happy to agree to buy BTC from you for $16,000 on Dec 22. So you sell all of those you can.
Next, you need to buy yourself some BTC. Over a week or so you quietly buy up about five billion dollars of BTC. This further drives the price of BTC up, all the way to nearly $20,000, giving even more impetus to investors to buy up your short contracts at $16,000, so you sell more of those at the same time. These short contracts continue to sell over the following week. This action drives the price of BTC down to $16,000 or so.
This leaves you a huge pile of money that you can hold as a reserve for what's about to come. Here comes your market manipulation.
On the morning of the 22nd, you start selling your BTC that you've accumulated at intentionally lower and lower prices. This starts to give investors pause, and as the price drops some fear starts to set in. Suddenly people aren't so sure of their position. Some of them start to sell. But they have to put in sell orders even lower than yours, which you keep issuing at lower and lower points in order to drive those sell orders down in price. Yes, you're taking a loss on the five billion dollars worth of BTC that you accumulated, but not a lot. You might take a loss of 25% or so before you're out of BTC to drive the price down. However, by that time you've started the ball rolling and it's got a LOT of momentum. So far the whole thing has cost you a few of billion dollars, but you're about to get that all back... along with a truckload of cash.
Pretty soon, BTC is starting to reach people's stop loss orders. These are price points that people have put in place where their BTC sells automatically in order to reduce their losses in the event of a BTC crash. This has the effect of driving the price even lower. That's because when someone puts in a stop loss order there's usually a gap between the trigger price and the sell price. For instance, someone who bought BTC at $17,000 wants to insure that they don't lose more than 10% of their investment in the event of a BTC crash. So they've issued a stop loss order that says, “When BTC reaches a spot price of $15,400, I want to immediately issue a sell order for $15,300.” The gap between the two is intended to allow time for the order to post, and the hope is that the price won't crash an additional $100 between the trigger and the order.
The problem is that there are other people out there who have stop loss orders placed that will trigger at $15,300 and issue a sell order for $15,100. Which triggers a new round of stop loss orders...
It's a cascade effect, and the more it cascades the more money you're about to make. Traditional markets like the NYSE and others have implemented systems to combat this exact tactic. In the event of a crash in the market, trading is halted if prices fall or rise more than a certain percentage point within a given time frame. These are 'circuit breakers' that halt trading if (in the case of CME equity trading) prices fall more than 7%. No such circuit breaker is in place at exchanges like GDAX, Bittrex, or Bitfinex.
Eventually the automated systems have cleared out all the stop loss orders and BTC finds an equilibrium point where there are enough buyers to halt the fall in price. In the case of December 22, 2017, it appears that point has been reached at approximately $11,000 depending on the exchange. All along the way, the fall in BTC price has been working against the buying pressure from people's pre-existing purchase orders, as well as folks who have been watching the drop and are just waiting for it to reverse. People like you, with your 25 billion dollars to spend on BTC.
When you started your run, BTC was $15,300. You had to sell all the way down to $13,500 before the cascade really started having a life of it's own, but hey. You sold your last BTC at $13,500. Now it's $11,000. Time to start buying.
Over the course of the next couple of hours, you quietly (or as quietly as you can so that you don't immediately drive the price back to $15,000) buy up 25 billion dollars of BTC at an average of $12,300 or so.
Remember all those futures contracts you entered into? You already know that you can sell all this BTC for $16,000.
Just for the sake of this hypothetical numbers example, let's run through the math. You managed to sell 25 billion dollars of BTC contracts at an average of $16,000. You also then managed to manipulate the market in such a way that you were able to purchase 25 billion dollars of BTC at an average price of $12,300. That means that you were able to purchase 2,032,520 BTC. You already have buyers at an average price of $16,000 for 1,562,500 of those BTC, for which you will receive your entire 25 billion dollars back. That leaves you with 470,020 BTC. What did that BTC cost you? Remember that original five billion in BTC that you purchased in order to manipulate the market? You had to sell that at an overall 25% loss in order to start the whole cascade effect. So your total loss is $1,250,000,000. THAT is how much you paid for 470,020 BTC. In other words, you now own 470,020 BTC that you paid $2,659 each for. Not a bad take, considering that the BTC you now hold is worth $6.1 Billion and rising as the market recovers.
Time to start selling futures contracts for $16,000 again in preparation for your exercise in driving the market back up.
Lather, rinse, repeat.
Welcome to BTC, Big Money. Nice to see you here. While we appreciate the injection of capital, it sure would be nice if you all weren't such asshats.