If regulators find DeFi to be “unconscionably unpoliceable” due to a prevalence of spoofing and other market manipulation techniques, their next step may be to ban trading on decentralized exchanges (DEXes) altogether, CEO of Singaporean crypto fund manager Three Arrows Capital, Su Zhu, warned.
In a recent blog post, he said that while spoofing is currently not a major issue on DEXes, this could change when these protocols start to introduce central limit order books.
Defined as the malicious practice of flashing “artificial” orders in the order book in an attempt to push the price in a certain direction, spoofing is today seen as an illegal form of market manipulation by regulators in most countries. However, in DeFi, where no particular country’s regulations apply, things are different.
“As central limit order books become viable in DeFi, it is likely that it will be completely impossible to do market surveillance of any kind, much less hold a court to determine whether spoofing has occurred,” Zhu said, adding that this could lead regulators to “disallow trading on decentralized exchanges entirely.”
Further, Zhu also noted that it remains an open question whether spoofing actually harms retail traders, arguing that “front-running algorithms” – not ordinary retail traders – are the ones that actually lose money against spoofers.
“You may wonder why it is a mandate of public policy to treat frontrunners as a protected class. Why can’t traders simply dynamically react to the existence of spoofers by ignoring all large orders in execution logic,” Zhu asked, concluding that although DeFi could become “a sort of spoofer’s paradise,” it would also be a useful test for “whether non-spoofers actually care about being spoofed or not.”
As reported last week, aggregate trading volume on decentralized exchanges reached USD 22.8bn in September, up from USD 11.3bn in August, which is more than a 100% increase.
Su Zhu’s warning that regulators may not look favorably at DEX market manipulation follows a high-profile case from last week where major investment bank JPMorgan was fined USD 920m by US regulators for spoofing in the precious metals and US government bonds markets over a period of eight years.
According to the Financial Times, the penalty given to the bank “far outstrips” previous punishments for such market manipulation, and signals that spoofing is “as serious a liability to banks as rate-rigging, corruption or money-laundering scandals” are.
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