Bitcoin ETF Pending Approval & its Barriers
Sometimes when the cryptocurrency markets fluctuate, there seems to be no reason behind the price movements; this leads some to believe that cryptocurrency markets are being manipulated. But does that make cryptocurrency markets any different than traditional commodities and securities markets? And what does this mean for the future of cryptocurrency trading and adoption?
Fraud and Price Manipulation
Cryptocurrencies exchanges have been accused of fraud and manipulation in the past. Fraud and manipulation are two of the risks that the SEC cited when rejecting nine Bitcoin-based ETF’s. Their report reads,
“the Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices”
The nine ETF’s were to be traded on CBOE; however, the SEC believes that it is possible for fraud and manipulation to occur in the market for the underlying asset — Bitcoin — and therefore disapproved the proposal.
Among the most notorious abuses are pump-and-dump schemes, in which traders talk up the price of a cryptocurrency before dumping it for a profit, hurting investors who bought as the price topped out.
Although regulations regarding cryptocurrency markets are becoming more clear, cryptocurrencies markets are mostly unregulated. Groups have been caught manipulating markets in the past, and pump and dump groups — where investors artificially inflated the prices of altcoins and then sell them for a profit — in public chatrooms like those on Telegram serve as evidence.
Similar schemes are banned in stocks. The Wall Street Journal reported in August that crypto “pump groups” had generated at least $825 million in trading activity over a six-month period.
Some of these groups were made up of tens of thousands of investors, and because these groups were ubiquitous FINRA put out a warning for investors to be cautious of fraud, scams, and pump and dumps.
The Black Box and Trading Bots
For the most part, cryptocurrency is a black box; the average investor receives little to no information about why the cryptocurrency market fluctuates when it does. Which is different from a traditional securities market, where news might come out saying a company’s profit for the quarter fell short of analysts expectations and then their stock declines.
While established markets like the New York Stock Exchange monitor for illegal trading and punish rule-breakers, crypto exchanges vary widely in their surveillance efforts. Most crypto exchanges are regulated lightly, if at all. The result is that crypto bots can be used to execute abusive strategies on an industrial scale.
According to the Wall Street Journal, trading bots can manipulate the cryptocurrency prices at will, which could be one reason why the price fluctuates as it does. In the SEC’s most recent ETF rejection, one of the commenters claimed that trading bots could “ drive prices above fair market value by over 300%.”
When Coinbase Pro, the cryptocurrency trading platform operated by San Francisco startup Coinbase, announced it would list the cryptocurrency 0x (ZRX), a move that put the “Coinbase effect” on display when ZRX surged nearly 40 percent on the news.
Data shows prices for ZRX began to surge on other exchanges a few minutes before Coinbase made its official public announcement at 17:00 UTC. But while there were whispers online about the possibility of insider trading, a charge the exchange has denied in the past, there’s another explanation that is perhaps more plausible.
Savvy traders may have been simply making use of well-timed trading bots, computer programs that automatically scout technical price charts and exchange APIs to identify actionable and profitable developments. The bots can then either immediately act on their findings by placing a trade, or send a signal to their users in the form of a message via social media.
Should a trader have acted on the notification from Lightning Signals, it would have allowed them enough time to purchase ZRX at a near 15 percent better price than the casual investor.
If a trader was utilizing Lightning Signals or a similar API bot, he or she would have been able to capture as much as 35 percent profit whereas the public would have had to settle for a more modest 18 percent grain, bringing in nearly half the profit.
The average retail investor does not have access to the trading bots that influence market prices. In addition, there are individuals in the cryptocurrency space who have enough wealth to move the market with one buy or sell order. But is this any different than traditional commodities and securities trading?
Recently, a former JP Morgan precious metals trader admitted to manipulating the precious metals market for about seven years. He was charged with commodities fraud, price manipulation, and spoofing — he also said he learned how to manipulate the market from senior traders at the company. As you can see, fraud and manipulation are not exclusive to cryptocurrency markets, prestigious institutions with a lot of wealth — like JP Morgan — have the ability — and exercise the ability — to influence prices in markets even when it is illegal.
And not only do entities with a lot of wealth have the ability to manipulate the markets, financial institutions typically have tools that allow them to make trades faster than the average investor. Traders who have high execution speeds are generally able to profit more than traders with slow execution speeds. The advent of high-frequency trading gave financial institutions the ability to leverage computer algorithms to execute a large number of transactions at a fraction of a second; this also gives institutional investors the ability to access and act on information earlier than the average investor.
As you can see, the same foul-play that occurs in cryptocurrency markets is also present in traditional commodities and securities markets. And although this may seem like a pressing problem for cryptocurrency exchanges, regulatory agencies have been stepping up to regulate cryptocurrency markets the same way they regulate traditional markets.
Who Regulates Cryptocurrency Markets?
It is beginning to look like the Commodities Future Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) will have jurisdiction over the cryptocurrency markets. Recently, The SEC has been prosecuting the founders of cryptocurrency exchanges for operating unregistered national securities exchanges. The SEC says that they,
“support innovation and the application of beneficial technologies in our securities markets. However, the Divisions recommend that those employing new technologies consult with legal counsel concerning the application of the federal securities laws and contact Commission staff, as necessary, for assistance.”
Just because a token offering is done over the blockchain does not mean that it is free from existing regulations. Bitcoin is considered a commodity and is under the jurisdiction of the CFTC, and The SEC has determined that even though some tokens are marketed as utility tokens, they ultimately serve the same function as a security and therefore, must register with the SEC before they have an initial coin offering.
More Regulation, More Adoption
Without some sort of regulatory oversight — you can count on their being fraud and manipulation present — especially because no regulation means there is little to no repercussions. That may be why the CFTC and the SEC have been regulating cryptocurrency markets and prosecuting companies in the space who have not complied with existing regulations.
Although that might be upsetting to some of Bitcoins earliest advocates, who supported the system because it could operate without government intervention or regulation, investors need regulatory agencies like the CFTC and SEC. The CFTC and SEC’s regulations give investors protections that make them confident that their wealth is secure from fraud and manipulation in the market; ultimately, we need regulations like that before we get a Bitcoin ETF and before cryptocurrencies undergo mass adoption.
Luckily, both government agencies and Exchanges themselves are taking steps in that direction.
For more information on digital assets, feel free to reach out to WhitePark Capital at vs@whitepark.capital, and be sure to check out our website www.whitepark.capital
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