Future Commerce and the Impact of manipulating commodity

Commerce is defined as “the buying and selling of things”. This holds in concept even today. If we were to see the past, we would see commerce as the trading of goods, i.e., the barter system. Moving further down the timeline humans began to trade with currency such as valuable stones. Your gold, silver, diamonds, rubies, etc. Soon later came the industrial revolution which brought with it what had found its roots in China. But was given more importance when America declared the dollar as the currency on which all currency rates would be based.

But now the current situation is quite different. Owing to the financial and economic literacy boom the definition of commerce has come to encompass a variety of components. We can now trade so many objects or to be precise commodities that accumulating wealth is now not the tedious task it used to be. Some of the conventional commodities that are traded currently are equity, bonds, and currency. There have also been a few unconventional commodities that have been created such as cryptocurrency, non-fungible tokens, baseball cards, mortgages, meme stocks, and many such commodities.

Conventional commodities have been researched to death. Manipulating commodities like these is what led to the formation of SEC and SEBI-like organizations. But the unconventional commodities, are the ones that need to be talked about. After Covid-19 commodities such as these became the literal key to unfathomable wealth. People became overnight millionaires.

But this is just the picture that is being seen through rose-tinted glasses. Sometimes this wealth is the result of ill-begotten means. There have been incidences where individuals or entities have used manipulative methods to achieve this wealth.

WallStreetBets and GameStop

WallStreetBets is a community of average Joe traders on the social media website Reddit. These people provide advice on stocks to buy and sell and conduct discussions on everything related to trading. On January 2021 a strange occurrence took place allowed that allowed paupers to exact retribution on the rich nobles, i.e., the trading and hedging firms.

GameStop was a video game retailer chain that had struggled for some time. Looking at a company that was a safe bet, bearish trading, and hedging firms were shorting the stock. This meant that these firms borrowed GameStop shares and sold them. Once when the price dropped, they would buy them back and return them to the lender. This was further causing the share prices to fall.

In the month of January, the most bizarre happened. This was caused by the action of the Reddit community called WallStreetBets. The entire community began amassing a large volume of GameStop shares which caused its equity to grow to $24 billion from $2 billion. The implication. Everyone who invested in these shares became overnight millionaires through this meme stock. But there were also downsides.

This was damaging for the entire Wall Street. The losses for hedging firms totaled approximately $6 billion. Melvin Capital founded by Steve A. Cohen’s protégé Gabe Plotkin had to borrow $2.75 billion just to stay afloat. It was unsuccessful in this endeavor since as of May 18, 2022, Melvin Capital was shutting down its business. Therefore, HNIs who invested in these corporate firms lost a crapton of money thanks to the unity of like-minded people.

(Reported Portfolio Holdings of Melvin Capital from July 2015 – July 2022)

This entire saga began with hatred towards the capitalists who earned their wealth through scrupulous means. Or so believed. But that is a matter for another day. This incident showed a certain flaw in the financial system. If enough people were to pool their resources together for a certain cause they could manipulate an entire equity market. Moreover, they could bankrupt a major hedging firm and bring it to the streets.

Cryptocurrency Manipulation

Cryptocurrency is the new watchword of the financial world. Cryptocurrency has become a subject that many possess functional knowledge of. But even this commodity has its flaws. Cryptocurrency has become associated with many unsavory and illicit activities such as black-market trading, money laundering, and terrorist financing. Moreover, it can be manipulated to be beneficial to a certain beneficiary. There are ways in which this can be accomplished.

(Graph depicting Illicit activities funded by Cryptocurrency)

Spoofing

Cryptocurrency spoofing is the process by which traders attempt to artificially influence the price of a digital currency by creating fake orders. Spoofing is accomplished by creating the illusion of pessimism (or optimism) in the market. Traders do this by placing large buy or sell orders without the intention of ever filling them. When investors do this, they trick other investors into either buying or selling, and the price of the cryptocurrency stands the possibility of being adjusted accordingly.

This was evidenced by the stupendous fluctuation experienced by Bitcoin in late 2017. In that period Bitcoin witnessed a high of $18,000 (19th December 2017). Investors who had invested in the currency for the long term benefited greatly. But on 7th February 2018, the price had fallen to $7,270.51. Notwithstanding the price, it had touched on 5th March 2021 i.e., $49,362.58.

This indicates how traders with adequate knowledge manipulate cryptocurrency to suit their short-term whims.

Pump and Dump

The most ubiquitous technique used in the crypto markets currently is pump and dump. A method that impacts its traders the most. It takes place when core market participants try to pump up the value of a coin until it gains attention. Once traders and investors jump into the market, the group dumps the coin for a neat profit. A low market cap shitcoin can be pumped easily and a lot of this manipulation is well coordinated by hundreds and thousands of users who come together on Reddit, telegram, etc. to execute this technique. It is also impossible to predict the exact time of the pump, or the dump, and this tactic does hurt folks late to the pump, late to the dump, or even those who participated in it.

Whale Wall

The Whale Wall technique is an old method that is not as prevalent as it used to be. It is a tactic where a trader will place a huge batch of orders with no intention of ever having them executed. The intent is to create the illusion of large demand or supply in the market. This was frequent in the period between 2013 and 2017.

What would probably happen would be a whale accumulating cryptocurrency secretly while markets would hit sell orders, and the sell wall suddenly vanishes as the whale pulls out his order after effectuating the act. This could also happen and vice versa. Whale walls and spoofing can create exponential profits for whales, as the same people take positions on futures markets too. They profit from volatility in a derivative market by manipulating price discovery in spot markets.

It was witnessed on July 19th, when approximately 79,000 Bitcoins were moved by a whale or whales to Coinbase to create a sell wall and induce a downward price. Normally, this quantity of BTC is bought and sold on OTC. However, the sell wall was executed out of no choice when prices did not fall to expected levels.

Wash Trading

Wash Trading is another version of the whale wall technique and is used to create an illusion of an enthusiastic market for a specific commodity. Just like other tactics, it is illegal to do this in developed financial markets but does not appear to face any issues regarding cryptocurrencies yet. Wash trading typically necessitates buying and selling the same commodity simultaneously by one individual or a coordinated set of folks projecting a false volume. Most traders look at the volume and liquidity of an asset before they jump in and quickly discover liquidity false alarms when wash trading prevails.

Stop Hunting

One of the most nefarious tactics deployed by crypto manipulators is stop hunting i.e., hunting for all the stop loss milestones in all the trades. It is used to force traders out of their positions by driving prices low enough to trigger their stops. The impetus for whales is to pick up the commodity at a lower price once multiple traders’ hands are forced out.

Most traders place their stop losses at key technical levels and absent other manipulation tactics. For example, if coin XYZ has stop loss positioned at a certain level ABC then many sell orders are enacted to push the price to these stops, once it attains key technical levels innumerable automated sell orders are executed with manipulators sweeping up the loot with almost immediate market recovery with many others following the manipulator’s buys on the buy orders.

Given crypto markets run 24X7, unaware traders wake up to discover their stop losses were triggered and the prices are back up to previous levels, but all their positions are lost. Given that placing stops is still essential to managing risk if the market is legitimately moving down, it becomes tricky to spot this technique to avoid being ambushed by whale attacks.

Thus, the market for any commodity is rife with manipulation. Any trader with a rudimentary knowledge of the market in question can manipulate it if he/she examines the market and all its components well enough. But what are the impacts of these manipulations? Understandably, these manipulations would cause ripples in the economy in some manner.

Let’s look at it objectively. To make this simpler we assume ceteris paribus exists in the market. A trader in a long position will demand a commodity over the quantity available in the market. This would lead to two things. Firstly, sellers would want to liquidate their positions at any additional cost(commissions, brokerage). Secondly, there would be an excess of the commodity in the market.

Therefore due to the excess supply, the commodity would get cheaper and the prices would fall. Surely the manipulation would end sometime. When it does the commodity ends up being dirt cheap since demand has now abruptly stopped but there exists an unused inventory of the commodity. This effect is called “burying the corpse”, similar to hiding a crime.

Burying the corpse is the main risk that the trader undertakes. If the manipulator sells the commodity he bought at a depressed price he is at a loss. Unless the gains realized from liquidating long positions at a supercompetitive price outstrip the losses incurred from burying the corpse, manipulation is futile.

This kind of unethical practice is what brings companies to bankruptcy. If one is to check the stock market one will find indexes, a basket of stocks with something in common. Imagine if one stock performs in such a chaotic manner then the entire index is affected. Leading to losses being borne by investors who invested in that expecting healthy returns. Nevertheless, these are risks that all investors and traders commence.

Commodity manipulation is a necessary evil that would stay with us forever since it’s a fundamentally sound economic practice. But these practices are not feasible for perpetuity. Economic frictions which form broken cash markets and liquidity considerations that are skewed towards consolidation or monopolies make manipulation a beneficial activity for the manipulator. All factors that support manipulation have been in various ways since the beginning of the commodity market. Thus no matter what asset humanity comes up with to trade, or how many regulations the relevant authorities bring in, commodity manipulation is an integral and undetachable part of commodity trading.

References:

Craig Pirrong, “The Economics of Commodity Market Manipulation: A Survey”, Bauer College of Business, University of Houston, February 11, 2017

John McDermott, “The Fortunes Won—and Lost—in the Mind-Boggling Rise of r/WallStreetBets”, https://www.esquire.com/lifestyle/money/a36395893/wallstreetbets-investment-fortunes-gamestop-inside-story/, May 13, 2021

Nathan Reiff, “Cryptocurrency Spoofing”,

https://www.investopedia.com/tech/what-cryptocurrency-spoofing/#:~:text=Cryptocurrency%20spoofing%20is%20the%20process,or%20optimism)%20in%20the%20market, July 16, 2021

Nitin Kumar, “Spotting the 5 Common Crypto Price Manipulation Patterns”, https://www.linkedin.com/pulse/common-crypto-manipulation-techniques-nitin-kumar-, July 21, 2021

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