The biggest news of 2017 has been the tremendous growth of the cryptocurrency industry. Recently passing $500 billion in total market cap, many of the leading digital currencies have seen their values catapult into record heights time and again over the past 12 months. Along with those gains, however, there have also been dramatic drops and swings even for bitcoin, the largest digital currency by market cap.
Investors and analysts have taken this to be a feature of the new industry, which no one fully understands as of yet. Some of the reason for the rapid price fluctuations could be bot activity, according to a recent report by Venture Beat.
Automated Traders Dominate the Short-Term Market
In this context, a bot refers to an automated trader which makes buys and sells automatically. (See more: How to Code Your Own Algo Trading Robot.)
Bots are preprogrammed to activate upon certain triggers, meaning they don't include the human emotional factor when making a trade decision. As a result, they have been blamed for a number of market crashes, including the 1987 Black Friday Wall Street crash, which saw equities drop by more than 30% in a single day. Nonetheless, bots remain incredibly popular in a variety of markets, and particularly in the burgeoning cryptocurrency space in short-term holdings.
Volatility that is already built into the market is only highlighted by bot activity. Venture Beat points to the crash of Neo, the "Chinese equivalent of ethereum" as one example. The token's price fell from $34 to $3.74 in mere seconds, then climbed back up to $34 just as quickly. Since then, flash crashes of this type have happened in other digital currencies as well. (See more: Bitcoin Had a Flash Crash Scare This Morning.)
Bots Manipulate Markets
Besides their hand in flash crashes, bots can also manipulate markets by artificially inflating a price. Human traders may be enticed to overpay for coins because of the activity of bots. The automated trading protocols can engage in a "pump-and-dump" scheme in just the same way as human traders; multiple bots buy up a low-priced currency in order to generate artificial interest in the coin, thereby pumping up its price.
Next, bots will sell off the asset when it reaches a high point. However, without new buyers entering the market, the price of the coin then falls quickly, and human investors are typically left holding a worthless currency for which they've overpaid.
How to Find a Bot
Unfortunately, it's very difficult to detect bot activity without complicated analysis tools. Price momentum and volume can be indicators, however. Still, even if you're able to identify bot activity before it takes place, the unregulated nature of the digital currency market makes it difficult for human investors to do anything about it at this point.