Let’s start off with a definition from Wikipedia:
In finance, cornering the market consists of obtaining sufficient control of a particular stock, commodity, or other asset in an attempt to manipulate the market price.
Investopedia expands upon this:
Most of the time, the idea of cornering the market is associated with illegal activity. Markets are intended to foster competition and allow for competitive price discovery. If someone has cornered a market by limiting the number of willing sellers and buyers, this process breaks down and can require regulatory intervention to restore it.
What does a cornered market look like? Perhaps the textbook example is the Hunt brothers’ manipulation of silver in the late 1970’s:
These usually end badly for the cornerer and can become systemic, rippling through to other parts of the financial system. For instance, the Hunts borrowed heavily to leverage their silver purchases, and the government even considered a bailout at one point lest the Hunts default on their loans and drag brokerages and banks down with them.
So if these end so badly, why go through with this silliness? Perhaps pride, power and politics play a larger role than simply profit. In the case of the Hunts, they truly believed silver was a safe haven in a time of paper currency inflation and recession. Sound familiar?
Who is DRW?
Donald R. Wilson’s firm is one of Chicago’s largest high-frequency traders, with over 800 employees. DRW does not run other people’s money or report financial results. Not all of their business occurs within a split-second; they execute longer-term trades as well. They’re a big player in derivatives markets, particularly futures.
In order to better understand DRW’s role in crypto assets, it’s important to first mention their legal battles surrounding certain trading approaches they’ve taken in the past.
The article below is a good starting point if you don’t have the time to read through the whole case…
In summary, the Commission asserts that DRW:
- Found a perceived flaw in a futures contract and exploited it.
- Trader described companies that took the opposite side of their bet as “suckers.”
- Bet was not as profitable as initially expected.
- Placed thousands of bids to move settlement prices in their favor (aka “Banging the Close”).
- Described contract as the “ultimate of illiquid products. No one else around.”
- Regularly pulled bids after 15-minute settlement period (aka “Spoofing”).
- Never got their bids hit.
Unlike most firms sued by the CFTC, DRW refused to settle, and the case went to trial in December 2016. Here’s an interesting bit from the CFTC post-trial brief:
Oddly enough, the judge has yet to make a ruling. The CFTC seeks a $13.5 million forfeiture of profit plus penalties. More worryingly, they also seek a permanent trading ban for Wilson and DRW.
As banks scale back, “we certainly have increased the amount of risk that we take in markets.” -Don Wilson via Financial Times
Perhaps the CFTC is wrong and has failed to prove manipulation in these thinly traded instruments by simply inferring ‘intent.’ However, here’s another enforcement action, this time brought courtesy of the Chicago Board Options Exchange…
On nine trade dates, DRW … submitted minimum increment option orders, or ‘safety bids,’ in addition to its ‘strategy orders,’ ensuring that certain option series were included in the final settlement calculations of the SOQ. This conduct impacted the final settlement calculation of the VXEM, VXEW, and OV futures contracts. As a result of this conduct, the final settlement calculations … included additional options series in the SOQ settlement calculation that otherwise would not have been included due to the Two Zero Bid rule.
Bloomberg breaks things down a bit:
Nevertheless, the exchanges safeguards haven’t been perfect, which suggests Cboe isn’t immune to being gamed. The exchange fined DRW Securities LLC, a unit of Don Wilson’s big Chicago-based trading firm, in January for alleged misconduct in settlement auctions for Cboe’s emerging-market stocks and oil indexes. DRW neither admitted to nor denied the allegations as it paid a penalty of about $1.5 million. Cboe said it couldn’t comment on the case.
Those aren’t the VIX, but DRW’s alleged actions might illustrate how Cboe indexes can be moved around. The exchange found that nine times in 2014 and 2015, DRW submitted options trades that caused the settlement auction to include orders that wouldn’t have otherwise been used in the calculation.
This is all a very polite way of saying that DRW ‘banged the auction’ with ‘spoof’ bids on options, manipulating the settlement price of certain VIX-like futures products. It’s troubling because this is essentially the same exact trading strategy that got them into hot water originally with the CFTC.
Basically, there’s a flaw in the way VIX futures are settled that allows big HFT firms to move the price by simply quoting S&P options without having to execute the trades. Here’s what that looks like:
The current auction system that CBOE runs has “significant flaws.” -Don Wilson via WSJ
There are now a total of 18 VIX manipulation class action lawsuits pending, so many that judicial authorities are considering whether or not to consolidate them for litigation in a federal court. Thus far, one investor has gone ahead and named DRW, which may also be revealed as one of the “JOHN DOES” in the other lawsuits (trading of SPX options on the CBOE is anonymous)…
So what does any of this have to do with Bitcoin?
In 2014, DRW set up a subsidiary named Cumberland Mining as a digital currency unit. Not much was known about them until a few Redditors and a blockchain analyst identified Cumberland as the winner of an auction worth 27,000 bitcoins seized by authorities from Silk Road. They ended up buying a total of about 70,000 bitcoins in these auctions.
“They were very early adopters, and they’ve got a massive lead over everyone else.” -Brian Kelly, founder BKCM Digital Asset Fund via WSJ
Cumberland describes itself as “one of the largest OTC liquidity providers in the cryptocurrency space.” Unlike their competitor Genesis Trading, Cumberland is not a registered broker-dealer with the SEC and FINRA.
Cumberland claims to have done over $20 billion volume in 2017 alone. According to a recent Bloomberg report, they offer over 30 cryptocurrencies and nearly 500 pairs for trading. They are also “selectively” involved with ICO’s, ergo companies can privately exchange the ethereum they raised for cash, with Cumberland.
According to Bobby Cho, head of Cumberland, “we also manage an inventory of different cryptocurrencies for our own account in order to run our trading business and manage the risk appropriately…We connect to any exchange that has meaningful volume.” How about the volume leader?
In fact, immediately after winning their first auction, Cumberland sent 2,000 bitcoin to a Bitfinex wallet address for customer deposits. Furthermore:
At least two bitcoin notables among those following the Cumberland Mining [Twitter] account are Fred Ehrsam, the Coinbase co-founder, and Phil G Potter, a manager of the Bitfinex exchange.
How about market-making? Ari Paul of Blocktower Capital spoke to Bloomberg last year referencing the bitcoin derivatives exchange LedgerX:
“DRW is a market maker there. There’s pretty low volume. A million dollars a day. I do expect them to have a lot of volume very soon. They are intelligently ramping up.”
Curiously, BitMEX recently opened up about their own trading desk:
Could Cumberland have a similar special arrangement with Bitfinex as a liquidity provider in return for low or no fees? They certainly have the capital, coin, experience and support from the parent company to pull it off. If so, they’ve surely been discrete about it…
Bitfinex is a particularly controversial exchange for many reasons, most of which have already been exposed and well-documented by an anonymous whistleblower. For one, ‘spoofing’ seems to be an almost daily occurrence, where we periodically see massive bids or asks on their order books, only to disappear prior to execution. Here’s one of the largest yet: an 8,000 bitcoin “sell” at a key price level…
Rarely do these walls get a nibble before the whole order is pulled. They’ve been spotted on GDAX (Coinbase’s exchange) as well to a lesser degree. Why might somebody want to do this? Well, they may want to execute some trades at a more favorable price on the opposite side of the market. They could conceal this easily with hidden orders…
Here’s a demonstration:
How about wash-trading? The Bitfinex trade engine actually allows you to trade directly with yourself. Look what happened last year when traders gamed the Bitcoin ‘hard fork’…
Bitfinex admitted to this activity occurring on their exchange despite being in violation of their terms of service. Besides creating phantom liquidity, wash trading is particularly egregious in an illiquid market, where someone with a big enough stack could move the price in either direction at will. Better still, if the market is efficient enough said trader(s) could manipulate the settlement of bitcoin derivatives on other exchanges. Who has every incentive to engage in these types of activities? Cumberland.
“We continue to have concerns that the way these futures contracts are pegged to these cash markets -which are less transparent- could result in dislocations in the future,” Richard Gorelick, head of market structure, DRW
This is all blatantly illegal trading activity that falls under CFTC purview:
Pursuant to this enforcement jurisdiction, the CFTC can investigate potential fraud and manipulation in the underlying virtual currency spot markets.
Furthermore, Bitfinex continues to allow the ability to spoof and wash trade on their exchange, despite receiving a subpoena themselves from the CFTC on Dec. 6, 2017. The market happily obliged, with back-to-back Bitcoin gains of 17% and 23% on the 6th and 7th, respectively…
How much market power DRW really holds is certainly debatable, but the recurring theme of questionable trading practices plus ties with a dodgy exchange is troubling, to say the least.
That’s all, for now.