There's nothing fake about it. If the liquidity were truly "fake", by definition his orders would never trade which defeats the purpose. The more his orders get hit, the more liquidity his bot provides which also means the more potential profit for his bot. I don't understand why so many love being outraged by even the idea of algorithmic trading without knowing the simplest principles of market making.
I think what he's saying is that, say the price is $100 and the daily volume is a few million dollars. And someone places a huge, say $50 million buy order at $98.
This implies to the market that there is a ton of demand not far from the price. It shows support for the price level, it shows demand, confidence in the product for sale, and it shows that the price is not going to drop anytime soon even if many people sell, as there's a big-shot with $50m ready to soak up any sell orders for weeks (as normally, daily volume is only a few million).
That's a signal to the market: there is demand, there is confidence, and there is very little downside risk. If I buy, it's likely the price goes up. If many people sell, a large buyer will soak up the price drop and so my risk is small.
When in fact, the guy who put a $50m buy order at $98 will cancel it as soon as the price drops from $100 to $99. He never intends to let that order execute. It's 'fake demand'. He's got some of the product and he's hoping that his $50m buy order is the gesture that fuels more demand, raising the price to say $105, at which point he sells his product, cancels his order, watches the price drop and buys some more product at cheaper rates.
This doesn't have much to do with algorithmic trading, mostly it's a manual set up and the only thing you program is for a bot to cancel an order you set up once it's close to being executed.
His solution is to say you can't just cancel an order right after you created it over and over again. In other words, he's suggesting that instead of an order book, trades ought to only be allowed to buy or sell options. e.g. if you want to buy $50m at $95, you can sell the option for traders to sell you coins at $95 for some timeframe. As any contract, it can't simply be cancelled, and remains valid for some limited time, which means you can't fake demand as once you express demand, you can contractually be locked in to exercising demand. It's not a great solution, don't get me wrong, but I can see where he's coming from.
Just to tie things back to other discussions that have been going on in HN lately:
>When in fact, the guy who put a $50m buy order at $98 will cancel it as soon as the price drops from $100 to $99. He never intends to let that order execute. It's 'fake demand'.
This is precisely spoofing and is illegal in the United States on regulated exchanges (not a lawyer...).
There are lots of reasons why regular exchanges don't use the the order standing times, but the simplest one is that spoofers can easily game that. Lots and lots of spoofers put orders in over the course of long periods of time. The issue is that they pull them all at once. Of course pulling all your orders at once can happen for any number of legitimate reasons so it isn't as simple as just banning that behavior.
> When in fact, the guy who put a $50m buy order at $98 will cancel it as soon as the price drops from $100 to $99. He never intends to let that order execute. It's 'fake demand'. He's got some of the product and he's hoping that his $50m buy order is the gesture that fuels more demand, raising the price to say $105, at which point he sells his product, cancels his order, watches the price drop and buys some more product at cheaper rates.
You can't reliably do that without a crystal ball.
Let's say there is a total of $1m of buy at $99.
Then Alice sends a $50m buy order at $98.
Bob sends a $51m sell market order. It will immediately match $1m at $99 and $50m at $98. Alice cannot cancel her order. (if the market in question doesn't support market order, the example still works for a limit order at x<=98).
If you change the example so that there's more depth above Alice's order, e.g. there's $500m at $99 and $500m is relatively large for the average daily volume, then maybe we can assume Alice will have time to cancel her order before it's executed. However, in that case you cannot claim that Alice's order will significantly affect the price.
You can't have it both ways: if Alice's order affects the price then Alice faces the risk of having her order executed; if Alice has very high probability of being to cancel her order, then it means it's far from the best bid/ask, and it won't affect the market much.
The point is that Bob is not putting in a $51m sell order when exchanges average $1m a day. You'll be hard pressed to find people with that kind of money. Entire funds have less than that, the Bitcoin Investment Trust for example, ran by Barry Silbert's Second Market, is a $36m asset fund.
Anyway, you can argue the exact numbers, I just mentioned some hypothetical ones. Fact is that big whales and spoofing does exist, it's a well known phenomenon on bitcoin exchanges, and of course is not unique to bitcoin. It's been part of any market place for a long time, it's called spoofing and it's usually illegal because it's manipulative and effective.
As for whether there is risk, yes of course there is risk. People still do it and it appears people have been successful. Especially in immature markets.
