Preamble: last week, I posted about ICOs (Initial Coin Offerings), and how they might be used to ‘print’ cryptocurrency. I’m very concerned by this. Because rather than being decentralised, the new wave of crypto-offerings appears to be placing ‘institutional’ power into the hands of the exchanges. The exchanges are the key point of weakness in the crypto-space. And because they are unregulated, they are essentially a law unto themselves. But that was mostly speculative theory. Today, I want to talk about Tether, and Bitfinex, and what might well turn out to be an example of this kind of activity.
Here are some terms that I’m going to use today:
- Tether: a cryptocurrency
- Bitfinex: the cryptocurrency/Bitcoin exchange with the largest flow-through of Bitcoin trading volumes.
- Margin trading: a method of buying or selling Bitcoins where the Exchange lends you the money/bitcoins to do it.
- Wash trading: a type of market manipulation, where you buy and sell from yourself in order to move the price (and/or create the illusion of market activity.
Market Manipulation is mostly illegal
Here’s something that you should know: public markets are relatively easy to manipulate. There are all kinds of things that a trader can do to move a price artificially.
This kind of activity has resulted in regulation.
Here is a quote directly from the SEC’s website:
Manipulation is intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security. Manipulation can involve a number of techniques to affect the supply of, or demand for, a stock. They include: spreading false or misleading information about a company; improperly limiting the number of publicly-available shares; or rigging quotes, prices or trades to create a false or deceptive picture of the demand for a security. Those who engage in manipulation are subject to various civil and criminal sanctions.
In an unregulated market space, however, there is no problem with “rigging quotes, prices or trades to create a false or deceptive picture of the demand for a security.”
So in regulated markets, activities like ‘wash trading’ are going to land you in trouble. In an unregulated market, go right ahead.
A Wash-Trading Guide To Manipulating The Price Of Bitcoin
Here’s how wash trading would work:
- Let’s say that the current market price for Bitcoin is $1,000.
- I buy a Bitcoin from someone on the market for $1,000.
- At this point, I am now ready to wash a trade.
- I start by placing a ‘sell’ bid into the market for $1,500.
- I then accept my own ‘sell’ bid, and buy the Bitcoin from myself.
- The trade settles at $1,500 – and the new market price for Bitcoin is $1,500.
To be clear, no money changed hands. But the market price has now changed. And there’s not too much risk to me with that sell bid (because if someone else accepts, then I’m in the money – if not, I get to do my wash trade).
But other market participants might watch this kind of price change and get excited. Which is what I want – because if I pull more people into the trade, I’ll actually be able to sell to someone at $1,500 – at which point, I’ll be $500 richer.
Now if you’re just a small player, with not much money, people are going to view your trade as an anomaly.
But if you’re a big player, with lots of capital to play with, then other potential investors might be persuaded that there is ‘real’ market movement.
The key points:
- You can artificially create the illusion of market demand by buying and selling with yourself; and
- The more capital you do this with, the more believable your illusion will appear.
How do you raise the capital to wash-trade?
Two normal ways:
- You use your own money; or
- You borrow it (ie. you trade on margin).
But there is a third way as well in the cryptocurrency space:
- If you can persuade an exchange to list it, you print your own cryptocurrency.
So let’s talk about Tether – a cryptocurrency seems to have attracted some suspicion on this last point.
What is Tether?
Curiously, Tether is a cryptocurrency that is apparently backed by fiat money.
I think not.
Most cryptocurrency fans are fans precisely because cryptocurrency is not fiat money. Meaning it cannot be inflated by a government or central bank.
But here is Tether:
And here is how they recommend you use it:
“An alternative to traditional currency deposit and withdrawal methods” at an exchange?
That is: you can use Tether as though it were real money. Provided that the exchange in question accepts it as an alternative.
And to be clear, the exchange would have absolutely no obligation to confirm that Tether is, in fact, “backed one-to-one by traditional currency”. If it’s happy to accept Tether at face value, then Tether will trade at face value.
As an aside, if you read the legal fine print, you might come across this phrase:
“There is no contractual right or other right or legal claim against us to redeem or exchange your Tethers for money. We do not guarantee any right of redemption or exchange of Tethers by us for money. There is no guarantee against losses when you buy, trade, sell, or redeem Tethers.”
Now perhaps that is legal speak. But to me, it says “Just because we back Tether with traditional currency, that doesn’t mean that we’ll allow you to redeem Tethers for cash. We may fulfil that obligation. But that’ll be at our option.”
And at worst, it implies that the ‘backing’ of tethers is possibly just a marketing ploy.
What is the market capitalisation of Tether?
Well here is a fun graph for you:Things to notice:
- The price has not really deviated from the $1 for every Tether.
- But the market capitalisation has been growing at a massive clip this year.
How is this possible?
Well, at the beginning of 2017, there were about 850,000 Tethers in circulation.
Today, there are about 380,000,000 Tethers. And every ‘jump’ that you see in the market capitalisation translates into a new round of Tethers hitting the market.
How does this correlate to Bitcoin’s trading price?
Well here is Bitcoin’s year-to-date price chart:
And here’s Tether’s market cap:
And here’s a combined chart from Twitter:
How should we be reading the fact that the price rallies in Bitcoin seem to be preceded by new influxes of Tether?
Are they unrelated?
Here is Bitfinex’s explanation for the sudden growth in Tether’s market cap:
“There are Institutional Tether customers that have their own bank accounts in Taiwan that are able to make an internal transfer to their Tether accounts, hence the new Tethers created.”
But the question I have in response is: “Why would an institution buy Tethers in order to buy Bitcoins, instead of simply buying Bitcoins directly?”
Oh, and for the record, Bitfinex is the exchange that honours Tethers as ‘USD-equivalent’.
Now let’s talk about margin-trading at Bitfinex
For my money, the biggest risk of a new altcoin is when it can be used to leverage a trade. In other words:
- The exchange allows you to borrow money from them for cryptocurrency trading;
- In order to do this, it requires collateral;
- If the exchange accepts your altcoin as collateral, then you multiply the amount of ‘capital’ you have.
- If the exchange requires a 10% collateral deposit for margin-trading, it means that every $10 trade requires me to place $1 in the margin account of the exchange as collateral.
- That is: $1 of margin collateral gives me $10 worth of capital to trade with.
- And if the exchange accepts my Tethers as collateral for all crypto-trading, then I can take $1 of Tether and use it to buy $10 worth of Bitcoin.
Question: which exchange accepts Tether as collateral?
Question: which exchange has the largest volume of Bitcoin trading in 2017?
And here’s the most curious thing: Bitfinex does not have access to any formal banking facilities. It used to, but was cut off (as I wrote about back in May). A quote from their chief strategy officer:
“We’ve had banking hiccups in the past, we’ve just always been able to route around it or deal with it, open up new accounts, or what have you… shift to a new corporate entity, lots of cat and mouse tricks.”
-Phil Potter, Chief Strategy Officer of Bitfinex
So to summarise:
- An exchange with no official banking facilities has the largest volume of Bitcoin trading volumes flowing through it;
- It is accepts Tethers in lieu of US dollars; and
- It facilitates margin-trading.
To cap this all off, what if I wrote that Tether and Bitfinex are owned and controlled by the same parent company?
Because they are.
There are two possible conclusions:
- Bitfinex created Tether as a workaround solution after they were cut off from formal banking channels for refusing to comply with KYC requirements. This may all look suspicious – but they are really just crusaders against regulation. And now they’re the dominant Bitcoin exchange, on the back of fiat-backed cryptocurrency. Or
- Someone (or a group of someones) is manipulating the Bitcoin market.
PS: a shout-out to Josh for pointing me in the direction of Tether, and to Rachel for doing a bunch of background research. Thanks!
Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha. Also, check out the RA podcast on iTunes: The Story of Money.
Stealthy Wealth September 7, 2017 at 08:17
Fascinating reading! I suspect this will be the first of many shenanigans to come out of cryptocurrencies…Reply
Leo September 11, 2017 at 07:11
John McLaren (@indiefutures) September 14, 2017 at 23:28
For the time being let’s talk about what you describe as a wash trade. It’s not really. But in any case that scenario can simply not happen on an exchange. What you are describing (I start by placing a ‘sell’ bid into the market for $1,500) is a limit sell order at $1500. (It’s a sell ask, not bid)
The next step you describe (I then accept my own ‘sell’ bid, and buy the Bitcoin from myself) simply can’t happen due to the ask/bid auction nature of exchange pricing. Your order will only be filled when the exchange price for the security is at that actual price. You can’t just fill an order when you want! It waits in a queue until the price reaches that point. You would have to put in an equivalent buy stop limit at $1500 but it would just cancel out with the sell order. If the price doesn’t reach $1500 your order won’t be filled. Limit orders are also only filled at the exact price you set. The danger is that there may be a lack of liquidity to fill such an order and you may only get partially filled as the price rises. A limit order cannot be filled at a lower price. It’s risky as you may get partially filled only to see the price drop.In highly volatile markets like crypto I seriously doubt anyone would try it with huge volumes even if it could be done. It could get very messy. If you want your total order filled you would need to use a market order but that introduces slippage as your order may be filled at various prices not selected by you. When spreads are big and the market volatile this is madness.
Then there is also the question of the trading software engine. Exchanges have a Self -Trade Prevention Functionality (STPF) which resides within the trading engine and provides various automated configurations to prevent self-trading of orders entered by the same firm or related firms; under the same Authorised Trader ID or the same account ID; or within the same Authorised Group ID or Individual ID. Outright-to-outright orders, as you’ve described and spread to same spread orders will be prevented from self-trading. This doesn’t affect spread option strategies. But even if an exchange decided to allow it there is no guarantee that the price will follow upwards. Anyone with that amount of money for large enough volumes will have a risk manager that 100% will decline the “opportunity”.
A true wash trade is a simultaneous buy and sell of the same security where the net profit is zero. This is done at the current market price not at a price you determine. An attempt at such a trade at a higher price, or lower price if you’re a short seller, will just cancel the trades. It’s mostly done to earn commissions and seldom results in price movement. To circumvent the STPF on the trading engine you could attempt a wash trade using 2 different exchanges. Buy on one exchange and sell on the other. The risk is huge though as their is no National Best Bid and Offer for cryptos and the exchange prices may not be in sync. This is often used for arbitrage and I’m certain their are traders doing it but it’s more to profit off small time delays in price parity as opposed to attempting to manipulate the price.Reply
John McLaren (@indiefutures) September 15, 2017 at 00:46
Continuing the above thread …. in your wash scenario you would have paid for the bitcoin twice. Once at $1000 when you initially gained it and once at $1500 when you bought it back at the higher price. Trading is a zero sum process. You theoretically lost $1000 in your transaction if it were possible. Unless you’re doing naked short selling of futures contracts (none yet for cryptos),you need to own the security that you offer up for sale. In this case you do. You bought it for $1000. As you already own it you can’t buy it again.The order queuing process of the exchange simply doesn’t function that way. It can only be sold to someone on the exchange who doesn’t own it. You could buy a new bitcoin but not the one you already own.It’s not really true when you say no money changed hands. If you were trading on margin the money changing happens when you need to settle your margin account. If your scenario were possible you’d owe them $1000 so they’ll be after you before your trade is closed 🙂Reply
HQ December 18, 2017 at 23:03
You’re wrong… because you keep applying the rules of ‘real’ securities and futures to Bitcoin.
You also seem to ignore the fact that one entity can have many discrete addresses or wallets, with absolutely no indication of who owns a wallet. This is why criminals love Bitcoin so much.
Also, the fact a crypto-coin transaction may not be confirmed for 10 minutes to several hours permits washing. This is called latency, and it is being exploited on a significant scale. By the time a transaction is confirmed, and the follow-up wash transaction is confirmed, the blockchain has already committed the first to the ledger, there is no auditing and investigating it. It’s done.
This is why the lack of regulation, oversight, and accountability make it a Ponzi pyramid. The $ price is not rising due to utility or value. It is rising because of pumping & dumping virtual coins within the virtual space of a cryptocurrency exchange. Actual dollar value is a masterful illusion.
Just look at the past week or two: every few days another ‘alt-coin’ is hyped, inflating the value (quoted in fiat dollars ironically) of those coins, and then the sharks move on to the next ‘hot’ coin… “rinse and repeat” process. Last week it was litecoin, monero, etc. This week it’s NXT, Ripple, etc. Next week it will be some other obscure coin which will be used to pump Bitcoin.
Market Cap is probably the most misleading term of all in cryptocurrency. I create a virtual coin from a SHA256 function with my computer, and suddenly printing that QR code into a paper wallet is now worth USD $19,000?
That is not a capital dollar investment, it is counterfeiting according to legal tender laws.Reply
HQ December 18, 2017 at 23:05
My above reply was to John M…Reply