For all the talk about bitcoin’s extreme volatility, a risk for investors that doesn’t get as much attention is market manipulation. To the extent that upstart crypto-trading exchanges have technology in place to root out wrongdoing, it’s often homegrown and may not meet wider industry best practices. Increasingly, however, academics and government watchdogs are digging into trading data to see what’s really going on.
One episode involves Chicago-based CME Group, which launched bitcoin derivatives in December. The futures contract is linked to an index that uses prices from four crypto exchanges (there used to be six—more on that later). After the launch, CME requested a large swath of trading data from crypto platforms Bitstamp, Coinbase, itBit, and Kraken to monitor for manipulation, according to the Wall Street Journal (paywall). Several of the exchanges balked at CME’s request and asked it to narrow its demand, which spurred the US Commodity Futures Trading Commission to step in and subpoena the data.
Bitstamp CEO Nejc Kodrič says CME’s request seemed over-broad, and the company didn’t feel comfortable turning over such a large, unspecified amount of customer data. That’s why the exchange asked CME to narrow the focus to certain customers and for a shorter time frame. Kodrič says the Luxembourg-based company is cooperating with the CFTC.
To date, neither these exchanges nor the traders using them have been accused of doing anything wrong. The issue this episode raises is about access to data so that surveillance experts can monitor for manipulation.
The authorities have reason to be wary. Vulnerable benchmarks were at the heart of a reputation crisis for the traditional financial industry. Banks have spent part of the last decade responding to allegations that traders colluded to manipulate benchmarks linked to interbank borrowing, foreign exchange rates, gold, silver, and other indexes.
Market manipulation is far from a new phenomenon, of course. Traders tried to corner the gold market in the 1800s. In the 1950s there was an attempt to buy up every onion (even those that hadn’t been harvested yet) in America to corner that market, to dictate the price. Thanks to a regulatory backlash, onion futures are now illegal in the US.
And now there’s bitcoin. New academic research about Bitfinex, one of the world’s largest crypto platforms, alleges that price manipulation on the exchange helped fuel last year’s huge bitcoin rally. University of Texas researchers behind the latest study (pdf) also suggest that better market surveillance is warranted. Bitfinex, incidentally, used to be a constituent of the index CME uses for its bitcoin derivatives.
“Our findings provide substantial support for the view that price manipulation may be behind substantial distortive effects in cryptocurrencies,” finance professor John Griffin and graduate student Amin Shams wrote. “External capital market surveillance and monitoring may be necessary to obtain a market that is truly free.”
Bitfinex CEO Jan Ludovicus van der Velde said in response that the exchange hasn’t ever engaged in market or price manipulation, and that tether—the crypto asset that allegedly facilitated the manipulation—couldn’t be used to prop up prices of bitcoin or anything else.
For CME, the index at issue is the CME CF Bitcoin Reference Rate (BRR), which was launched in 2016 and is administered by London-based Crypto Facilities. CME uses that benchmark for its bitcoin futures contract, which essentially allows traders to speculate on, or hedge, bitcoin’s price at some later date. The index used to have six exchanges contributing to its prices, but two have been suspended. One of those exchanges is Bitfinex, which was taken out of the index calculation before CME’s bitcoin futures started trading.