Wash Trading Bitcoin: How Bitfinex benefits from fraudulent trading

Wash trading is an epidemic in the Bitcoin markets. For those that are not aware, a wash trade is where a person buys and sells to their own order.

For a more in depth explanation, see here.

From my very first post I’ve been warning about people wash trading.

Originally I presumed that wash trading was being performed by two accounts controlled by the same entity. However, I’ve been informed by reliable sources, and confirmation, that this is in fact, even easier than I thought.

New information was provided to me from some traders, and in my honest opinion only causes me to believe that this is even more likely a criminal operation.

I originally presumed it was two accounts because, no way in the world would Bitfinex allow trades between the same account. That would just be stupid of epic proportions…

I was wrong.

Update: October 22nd, 2017. Bitfinex has officially responded to these allegations.

Bitfinex employee “Andrew” regularly acts as PR for Bitfinex on Reddit. Source (Archive)

The dirty secret about Bitfinex’s trade engine…

I want you to think of a company building an airplane.

This company is going to acquire the resources, build the wings, cockpit, fuselage, tail, the engines, windows, doors, life support systems, and so on…

I want you to think of Bitfinex building a plane just like that. They have what appears from the outside to be a real airplane, wings, tail, fuselage, etc.

To the untrained eye everything looks normal. It’s definitely a plane.

Now imagine if this plane did not have a fuel tank, and they sold this airplane to someone, knowing it had no fuel tank.

No plane manufacturer in the world would make a mistake of this proportion, in fact, you’d have to wonder if it was intentional.

That’s Bitfinex. They built an airplane, and intentionally did not put fuel tanks in it. No reasonable person would expect such a product to work correctly, yet they produced it and sold it to their customers, and investors.

And they knew it.

PSA: The Bitfinex trade engine ALLOWS for WASH TRADING

The trade engine on Bitfinex will allow you to buy and sell to your own orders, the procedures to do it are as follows (which will likely be ‘fixed’, or partially fixed after this post…)

  1. Place a buy order, or a sell order, for Bitcoin or anything that trades on Bitfinex.
  2. Place a matching order opposite of your buy or sell order.
  3. The trade engine will execute trade against your own order.

Here is a video of what this looks like from an outside observer.

Take note that this is only the most obvious form of wash trading. You can’t detect wash trading that is disguised properly externally.

Someone writing an exchange trading engine on a normal exchange, one of the very first things the trade engine will do, is ensure your orders don’t match one of your own.

There’s zero legitimate reason to conduct a wash trade, except to manipulate the market, but the biggest reason why an exchange would want to prohibit wash trading is because simply…

Wash Trading is illegal!

Source

But in case you don’t believe me and think I’m FUD’ing about wash trading only applying to ‘things which are not crypto’… here’s a real world example…

LedgerX is a new kid on the block, a bitcoin swaps facility that is fully regulated by the CFTC. You’ll notice in their API documentation that they will reject orders they detect as wash trading.

http://docs.ledgerx.com/

Bitfinex has no such mechanic.

And as a result, we see things like this…where people successfully wash traded tens of millions of dollars of Bitcoin, and these numbers helped artificially inflate trade volumes on Bitfinex.

Wash trading of short positions on Bitfinex.

Bitfinex has admitted that they have wash traders

Source (Archive)

I want to point out the irony:

  1. They claim wash trading is a violation of their Terms of Service.
  2. Their own trade engine will match and execute against orders belonging to the same account. Something trivial to prevent.
  3. They did not ‘fix’ their trade engine after the August 1 event where they had tens of millions of dollars of wash trading.

And take note, traders on Bitfinex jumped at the opportunity to take advantage of Bitfinex’s BCH distribution scheme. To think they wouldn’t wash trade to manipulate prices (up, or down) by engaging in fraudulent trades is a pipe dream.

They conducted tens of millions in USD of fraudulent trades to ‘steal’ BCH. They’ll wash trade in a heartbeat in order to wipe people out of their positions under ordinary circumstances. I guarantee you Bitfinex didn’t ban a single one of these traders.

Just like they don’t ban people for spoofing which is also illegal.

So, obviously, this is a bug right?

Not quite. In an interview, Phil Potter has admitted there might be ‘legitimate’ reasons to wash trade.

Phil Potter is directly asked the following question:

“For clarity, are you still permitting this practice of self-funding and doing what we call 1x hedge shorts? Is this still permitted in general?”

NOTE: THIS IS A VERY CREATIVE WAY TO DESCRIBE WASH TRADING.

Phil Potter: “It depends on what the purpose is.

Later, Phil Potter mentions “A lot of people were wash trading to themselves.”

This can only be possible if the trade engine allows it, which it does.

The interviewer then goes on to say…

“So, as a matter of policy it seems like Bitfinex still permits it but on a case by case basis, but determined if there is any manipulative practices that require sanction?”

Phil Potters response, was the wrong answer.

Phil Potter: “I’m not going to acknowledge that the way you say it per-se…”

Wash trading is illegal, and even worse than spoofing, as trade volumes directly influence the value of their business. Phil Potter knows their trade engine will execute wash trades.

He’s not stupid.

Oh, and since a lot of people in the crypto-currency sphere believe in “CODE IS LAW”, the Bitfinex trade engine is programmed to process wash trades. The code disagrees with what Bitfinex claims to be their Terms of Service.

And it has been like this likely since Bitfinex started.

Bitfinex committed fraud against their investors

Bitfinex has likely had wash trading going on since the very start. What percentage of their trading is wash trading? We don’t know.

If you recall, Bitfinex issued equity for their business and sold this equity to people holding BFX tokens. How did they determine the value of their business?

Volume & Expected trading fees.

Bitfinex knowingly issued equity based on a value, where the value came from a statistic that their own trade engine allows people to artificially inflate, by executing trades with themselves.

In March of 2017, Bitfinex increased the valuation of their equity from $200 million, to $250 million. Phil Potter admitted that this helped drive people to convert to equity.

Bitfinex was in a crunch. They claimed their “BFX token” was causing them problems in getting audited and establishing new banking relationships, so they were quickly trying to retire these tokens and coerce BFX token holders into converting into equity.

Although 6 months after they redeemed the BFX tokens, still no banking.

Their ‘valuation’

Interestingly, the valuation of their company seemed to have shifted up as they they lost banking.

Originally, their valuation was at $120M (6x earnings, earnings which are based off of volume…), and they wanted to ‘raise’ $80M as we can see from their shareholder information.

Shareholder Information

What’s interesting is they ‘raised’ money with BFX tokens, BFX tokens were debt they owed, someone agreeing to cancel this debt in exchange for equity doesn’t actually put money in their bank for them to use. This is likely the reason why they had to increase the amount by another $50 million.

But apparently, losing all access to banking increases the value of your company by $50 million dollars. Who knew?

Where have we seen this before? Right here.

I’m sure that BFX token holders, who lost money in the hack, that are now being asked to convert to equity in Bitfinex… were informed of this prior to converting to equity…. right?

If not, that seems like a criminal omission. Bitfinex was aware of problems on March 23rd, with a formal notice from Wells Fargo on March 31st.

How many BFX tokens were converted to equity between March 23rd, and April 3rd with token holders being in the dark about the problem?

Sidenote: Bitfinex admitted they knew their lawsuit was bullshit, prior to filing it.

I don’t know about you, but I would argue that Bitfinex announcing they had banking problems publicly would be pretty bad for BFX token to equity conversions…so they waited until everyone converted their BFX tokens before telling people the bad news.

Bitfinex used so-called ‘reserves’ to pay back the remaining outstanding tokens that did not convert to equity.

  1. These ‘reserves’ came from them seizing funds from their depositors in the first place.
  2. Don’t forget that these people could not actually withdraw this USD. The only way these people could receive anything, would be to… buy Bitcoin from the exchange. Bitcoin prices were spiking up from this.
  3. These interviews are from April 3rd. There was never any mention of their banking shutdown. A critical piece of information. No questions were asked about this and one of the individuals in the interview segment appears to have converted to equity and never mentions this big news, indicating they did not inform equity holders or perspective buyers.

So let’s review:

  1. Bitfinex valued their company off of their earnings which primarily comes from trading volumes, a statistic they know people can wash trade to artificially inflate.
  2. Bitfinex likely did not inform outstanding BFX token holders, that they were knowingly suffering from banking problems prior to converting their BFX tokens into equity. A material omission that is likely, fraud by omission.

If you were holding BFX tokens and were asked in a hurry to convert to BFX equity and YOU found out they were having a banking crisis, would you convert to equity?

If you knew that their exchange software platform permitted wash trading, and the value of their equity was based off of their trade volumes, would you convert to equity?

I don’t think so.

I propose a new logo for Bitfinex.

They forgot to mention the leaf is attached to a lemon. Oops.

Conclusion

The truth is, we will never know how much of Bitfinex’s trade volume are in fact wash trades, and if they knowingly allow wash trading, chances are logs would be sparse, or just outright fake.

They probably would not want their transaction logs leaked and everyone to figure out the scheme, like when MtGox’s transaction logs got leaked resulting everyone figuring out about Marcus and WillyBot.

Absent those transaction logs being leaked, we likely still would not know to this day what happened with MtGox.

But it’s likely wash trading has been going on with Bitfinex since the day they started. It was after all, founded by a guy who promoted a ponzi scheme, and even tried to start his own.

Source (Web Archive)

And the current people that operate Bitfinex are no stranger to engaging in less than ethical behavior…like insider trading or… possibly front running their own customers.

Phil Potter does not trade bitcoin. He sells bitcoin on the way up and buys it on the way down. Contrary to what people may think, this isn’t trading at all. Honest.

Bitfinex will likely either deny these allegations, or claim they will ‘fix’ their trade engine, and by ‘fix’ likely fix it so that a casual trader or researcher can’t execute a wash trade, but a whale can.

Their engine allowing wash trading is intentional, it’s not something they forgot to put into their exchange platform for several years and we’re just now learning about it. It’s not an oversight.

It’s deliberate, especially when they did not fix it after August 1st.

You should take their claims with a grain of salt, because you might remember that Phil Potter of Bitfinex denied that spoofing was going on, and I immediately provided a video showing $14 million USD in spoofing activity.

This is why I record trade activity as the charts and price history don’t tell the full story.

Trade carefully.

-Bitfinexed