Are Bots Controlling Crypto Markets?

3 min read

So, it’s time to buy some of that cryptocurrency you’ve had your eyes on. You’ve done your research, the market price is low enough, and you’ve decided that it’s the right time to pull the trigger.

You head on over to Binance and place your limit order just below the prevailing market price at the top of the buy side of the order book, expecting that a slight dip in the price will allow your order to be quickly filled.

But hold on…what’s just happened? Immediately after placing the order, you notice another buyer placing a large order with a marginally higher price, which thus nudges your order down the queue.

“Fair enough” you say, as you decide to up the bid price of your order to retain ‘pole position’ in the queue, and ahead of your new competitor once more. But yet again, the competing bid instantly outmatches your new order by raising their own price upwards.

And before you know it, that attractive pricing opportunity you wanted to take advantage of has vanished. How annoying!

Why does this happen? In a word, bots.

What is a bot?

A bot is an automated trading entity that is programmed to identify market trends and execute trades automatically. Using algorithms, these robot traders can replicate what human traders would do in response to various market scenarios.

But crucially, bots can process information and make trading decisions much faster than any human can. And what’s more, they only continue to get better. They use reams of market data to analyze trends, improve their algorithms, and ultimately make more informed – and more profitable – trading decisions.

Today, bots are employed across many financial markets by high-frequency traders to exploit small pricing anomalies. Indeed, markets such as currencies have undergone something of a bot revolution in recent years. The days of crowded trading floors overflowing with traders shouting “Buy!” and “Sell!” are gradually becoming a thing of the past. And in their place have come electronic trading facilities and rows of computer servers, as automation takes hold.

perfect match

Bots and crypto markets: a perfect match

Bots are now proving especially popular within the crypto community, ranging in sophistication from free services designed for everyone, to more expensive subscription-based bots for the professionals.

In fact, crypto exchanges are proving the ideal playground for bots to expand their influence:

  • Unlike traditional financial markets that normally close on evenings and weekends, crypto markets are open 24 hours a day, 7 days a week. This makes them ideal for automated trading – humans sleep, bots don’t.
  • With some cryptoassets now tradeable on dozens of exchanges, the abundance of arbitrage opportunities that have arisen can be more efficiently exploited by bots than by traders.

Last year, Bloomberg pegged the amount of automated Bitcoin trading on some exchanges as high as 80% of total transaction volumes. Bots might also be partly responsible for the massive price swings we have seen throughout crypto markets. According to a 2014 study of global stock markets, it was found that although algorithmic trading made those markets more liquid and efficient, it also made them more volatile.

But what is certain is that a considerable chunk of exchanges’ order books are being influenced by bot activity. And frustratingly, these bots can induce traders to buy at a higher price or sell at a lower price than they initially intended. Indeed, it is often the case with limit orders that bots will be the highest bid and/or lowest ask prices in the market, and throughout much of the rest of the order book.

Moreover, bots are annoying to deal with! Seeing your bid being outmatched almost instantaneously, and by a robot – not even another trader, can be very irritating, especially if you’re placing your initial order with the intention of capitalising on what you believe to be a market ‘mis-pricing’.

As for market orders, one might also observe a series of bot orders of negligible quantities existing close to the market price, before the first order of any real significant quantity is found further away from the market. Again, the bots are trying to trick you into placing a market order that will be filled instantly, but most of which will be filled against the big order at a worse price.

Countering bot activity

It can be tempting to ‘outdo’ the robots by simply resubmitting your limit order with a slightly ‘worse’ price – i.e. a buy order that is marginally higher than the bot’s bid price, or a sell order that is marginally lower.

Although such a strategy for a one-off trade may not significantly harm your end-of-day profit, if you’re a serious crypto trader making several trades across multiple exchanges every day, these small but frequent nuisances will inevitably amount to a sizeable loss in the long-run.

As such, it might be preferable to keep your order at the price you initially intended. If there is at least some volatility in the market then your order will be filled, it may just take longer to do so.

Or if you’re not in any particular hurry, taking a minute to observe the behavior of the order book is also recommended. Often, bot orders will show up and then suddenly disappear, or move around the book due to constant price adjustments being made. By trying to identify the intentions of the bots, you may end up being in a more informed position with respect to how and when you place your own order.

Of course, buying a bot yourself might also help. As more data is collated regarding the price behavior of various cryptoassets, these machines are only going to evolve further and become even more sophisticated in their trading competency.

But whatever you do, being aware of the existence and influence of bots will help prevent to you from being suckered into settling for sub-optimal trading positions.

Dr Justin Chan Dr Chan founded (DDI) and is the CEO for JCube Capital Partners. Specialized in strategy development, alternative data analytics and behavioral finance, Dr Chan also has extensive experience in investment management and financial services industries. Prior to forming JCube and DDI, Dr Chan served in the capacity of strategy development in multiple hedge funds, fintech companies, and also served as a senior quantitative strategist at GMO. A published author at professional journals in finance, Dr. Chan holds a Ph.D. degree in finance from UCLA.

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