Self-regulation could help end crypto price manipulation

Author: Olly Jackson | Published: 16 Jul 2018
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BitcoinThe Department of Justice (DoJ) and the Commodities Futures Trading Commission (CFTC) have opened up an investigation into price manipulation of cryptocurrencies, amid allegations that the practice is rife. Self-regulation, which has been used in other markets to solve this kind of problem, could be the answer for cryptocurrencies.

Regulators are concerned that investors are opening up transactions to encourage others to either buy or sell a coin and then refuse to complete the transaction, a practice also known as spoofing. There are also concerns that wash trading and so-called pump and dump schemes are taking place.

These practices are banned in conventional financial markets but given the cryptocurrency market is largely unregulated, investors may have been getting away with these illegal practices for some time. The move confirms that authorities are viewing cryptocurrencies in the same light as traditional financial investments and the same market rules apply.


"Exchanges are the first line of defence and are capable of monitoring trades"


According to Ashurst partner Tara Waters, the regulatory landscape remains uncertain and this has opened the door for people to take advantage.

"Exchanges are the first line of defence and are capable of monitoring trades," Waters said. "We know traditional platforms utilise monitoring teams and technologies and I see no reason why a crypto exchange that wants to be seen as trustworthy and credible should not be taking active steps to limit abuses."

Exchanges in securities or in derivatives markets, and particularly the futures market, are often bound to a self-regulatory organisation, effectively to police an exchange. These have an obligation to report any suspicious behaviour directly to the regulator and in the event that illegal activity is taking place, exchanges may have to suspend trading.   

KEY TAKEAWAYS

  •           The DoJ and the CFTC have launched an investigation into price manipulation of cryptocurrencies, concerning spoofing, pump and dump and wash trading;
  •           Self-regulation has been used in other markets to solve similar problems and could be effective for the crypto market. The Winklevoss twins are planning a new Virtual Commodity Association which would create new global standards;
  •           The crypto regulatory landscape remains unclear, with uncertainty about the status of Ripple still;
  •           Some exchanges have been accused of falsifying trade volume, slippage and fuelling a bitcoin bubble.

The Winklevoss twins, who were involved with the creation of Facebook and founders of the Gemini exchange, intend to create the Virtual Commodity Association – cryptocurrency’s own self-regulatory organisation - which would develop industry standards and work with the CFTC to prevent fraud and other illicit activity.

CFTC commissioner Brian Quintenz said in March that a private cryptocurrency self-regulatory organisation should be adopted that could help to create global industry standards and would also bring cryptocurrency exchanges in line with conventional exchanges.

Bitcoin and other altcoins are considered commodities and within the CFTC’s jurisdiction. The regulator is able to issue trading bans, take out injunctive relief and take back any profits made. But problems arise when the many regulators in the US believe that they do not have mandate to enforce against bad actors within the cryptocurrency system.

The longstanding debate on whether a token is a security or a commodity is confusing matters further and clarification is needed soon so investors and exchanges know their position.

Ripple has been subject to a lawsuit filed in the Superior Court of California claiming that the company used the sale of its XRP token to fund its operations of the XRP ecosystem, a blockchain favoured by financial institutions. This would fulfil the longstanding Howey test’s definition of a security. The decision as to whether Ripple has been offering an unregistered security would impact any exchange that sold the coin, including all non-US exchanges across the world.

Waters believes that clarity rather than new regulation is necessary. "For the time being the existing laws and regulations seem to cover the crypto market sufficiently, although increased clarity and guidance as to their application are welcomed," she said.

Some much needed clarity is slowly being offered. The Securities and Exchange Commission declared Ethereum, the world’s second biggest cryptocurrency by market cap, not to be a security last month. In the ruling, William Hinman, director of the SEC’s division of corporate finance, said when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. This means the ability to identify an issuer or promoter to make the required disclosures becomes difficult and less significant.

SEC chairman Jay Clayton said last month that bitcoin is not a security as it acts as a replacement for sovereign currencies. The same would apply for other altcoins, those issued on the bitcoin blockchain.

The original issuers of Ripple held onto a large proportion of the coins ever since it was first issued. As Ripple depreciates in value, it is believed that it could benefit the original holders of Ripple.

The SEC’s suspicions rise when issuers retain more of the coins following its issuance. Often founders of a token or coin retain a significant number of coins, but it is more like 30% to 40%.

"Manipulation appears to be quite rampant," according to a CEO of a fintech publication. "However, exchanges are certainly working to reduce the pervasiveness of price manipulation and ability for individuals to engage in manipulative activities."

Earlier this year, accusations were levelled at cryptocurrency Tether, which is said to be pegged to the dollar, for manipulating the bitcoin market. Inconsistent pricing data suggests that Tether was used to buy bitcoin during late 2017 and then more Tether was issued after Bitcoin’s price dipped. This would be then used to buy more bitcoin, fuelling a bubble.   

Some exchanges have also been accused of falsifying trade volume and what crypto investor Sylvain Ribes refers to as slippage – the percentage change between the observed mid-change price and the lowest price that one must consent to sell the asset.  

"It is hard to say it is more widespread – alleged fraud and manipulation of currencies is not new, and is already illegal," Adam Lurie, head of Linklaters’ US dispute resolution practice said. "In the forex and other matters, the DoJ and CFTC continue to demonstrate their resolve, but if there is wrongdoing in the crypto market, the DoJ and CFTC will pursue and prosecute it."

The investigation is ongoing, but whatever comes out of the investigation, self-regulation could be necessary to introduce new global standards and provide more protection to the investor. This becomes even more crucial if clarity from regulators is not offered soon.

See also

Putin warns crypto should be treated with caution

Japan’s separate rules for crypto could be the answer

US crypto regulation could be restricting blockchain development