Cryptocurrency: Market manipulation, manufacturing demand and artificially creating value

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You may have heard about pump-and-dump schemes… These are syndicates collaborating to buy up a large amount of a particular token to inflate the price and then selling (dumping) it just as quickly at higher price. What about some of the other tactics being used, such as market manipulation, trade manufacturing and artificially creating value in a slumped market. Who’s doing it? Well, it’s probably more people than you think… The problem with decentralised cryptocurrencies is it can be very difficult to figure out what’s really going on in the background.

This article seeks to explore some of the activities being undertaken by businesses and cryptocurrency startups using these strategies to preserve and retain their token value.

  1. What’s going on?

The cryptocurrency market is in a down-swing (for various reasons). Due to trading pairs and co-dependencies when Bitcoin and Ethereum start dropping in value all the other tokens often suffer harder hits due to their reliance on these major players. Naturally, businesses that have completed an ICO and are listed on secondary markets are forced to start exploring ways of preserving their token value.

Cryptocurrency trading is still a relatively unregulated space. Large, centralized exchanges such as Coinbase, Binance and Kraken revel in being viewed as the major players providing security and liquidity across a wide range of tokens. They also impose rigorous compliance requirements for tokens wanting to list on their exchanges in a further effort to create the appearance of legal security and trust.

Whilst admirable, none of these checks and balances seem to address market manipulation and artificially creating the appearance of demand. The ability for companies or individuals to effectively manage their own token price by buying and selling tokens to increase demand is more prevalent than you might expect. Given the (relative) anonymity of most tokens it’s even harder to trace and regulate how/where the manipulation is coming from. Whilst some exchanges such as Bittrex and Cobinhood have publicly condemned such behaviour, there is very little positive action being taken.

So, should we be concerned when businesses that have completed an ICO, launched their token and listed on secondary markets start manipulating their own token price by buying/selling their own tokens off the market?

  1. Market manipulation

Market manipulation can be broadly classified as any activity that is a deliberate attempt to interfere with the free and fair operation of a marketplace and create a false or misleading appearance of trading activity whether it involves a product, security, commodity or currency.

A gentle reminder of the current Australian regulations in relation to financial products comes from a recent decision[1] involving a 31 year old man who found himself in the District Court of South Australia facing market manipulation charges pursuant to s.1041A(c)[2] and s.1041B(1)(a)[3] of the Corporations Act. Stefan Mark Boitcheff pleaded guilty following an investigation by ASIC into a number of trades utilizing contracts for differences (CFDs) and shares.

Between 2013-2014, Stefan executed over 121 transactions in CFDs relating to Anteo Diagnostics Limited (ADO) shares which had the effect of creating an artificial price for trading ADO shares on the ASX and creating a false or misleading appearance of trading activity.

The reasons behind imposing strict trading rules are to prevent fraudulent activity and misleading conduct. In order to promote free market trading, investors need to be assured that publicly accessible exchanges are presenting a true and fair valuation of a particular asset. The obligations imposed on public trading activity are understandably high given Australian policy has traditionally erred on the side of caution when protecting investors.

  1. Misleading and Deceptive Conduct

ASIC recently confirmed they are stepping up their activity in this space and are actively reviewing ICOs that may be engaging in misleading or deceptive conduct. This shouldn’t come as a surprise when considering some of the blue-sky white papers and social media activity of projects trying to drum up hype and speculative value pending a public sale.

However, some projects may not be aware that arranging for tokens to be bought/sold on secondary market in order to artificially create the appearance of demand and liquidity may also be classified as misleading and deceptive conduct.

  1. So, should cryptocurrencies be treated differently?

The short answer is they probably shouldn’t be from a policy perspective… Whilst cryptocurrencies still seem to exist as an ethereal asset class across the globe that can be anything from a capital asset, stock, security interest or actual legal tender the majority of token holders still acquire tokens with a view to realizing a profit or trading their tokens at a later date. Whilst this may not necessarily involve any crypto-fiat conversions, it involves a constant redistribution of wealth and trading within the token economy.

The actual ‘price’ of a token is a highly speculative determination made by a multitude of factors including demand (buys/sells), exchange listings and arbitrary determinations made by individuals about what they’re willing to pay for it.

From a strict policy perspective, there is little reason why traditional trading rules shouldn’t apply to cryptocurrencies given the huge amount of risk and lack of standardized compliance requirements. Market manipulation and artificial demand creation is already happening on a daily basis, which realistically means exchanges become a very poor indicator of ‘true’ token value.

Notwithstanding this, I have some theories about why cryptocurrencies may continue to evade some of the traditional trading regulations:

  1. Well developed tokens have built-in game theory principles that underpin the token’s qualities. These principles promote co-creation of value and discourage bad actors. Market manipulation is a harsh word for something that may be a tool to co-create value within an ecosystem, particularly for tokens that have real-world utility.
  2. Jurisdictional limits. The rise of exchanges operating across multiple countries and jurisdictions creates an array of problems for regulators. The increasing popularity of decentralised exchanges such as IDEX and HADAX promotes further uncertainty as regulators would be forced to conduct independent audits of blockchains in an attempt to track down suspicious activity. Given the relative anonymity of cryptocurrency trading, it’s also highly unlikely auditors would even have the ability to then trace transactions to individuals or businesses.

The unfortunate reality is due to the decentralized nature of cryptocurrencies all the policy reasons, rules and regulations I’ve discussed may be irrelevant when there is no method for imposing compliance. Regulatory divergence across jurisdictions has further complicated the situation resulting in a complete lack of industry standard compliance.

For better or worse, we may have to submit ourselves to ignorant bliss and continue to ride the speculative wave of cryptocurrency trading where no one really knows what’s going on in the background.

 

This article is intended solely to provide the author’s opinions and general knowledge on the matter of interest. It is not intended to constitute any form of legal or financial advice and should not be relied upon for those purposes.

 

[1] https://asic.gov.au/about-asic/media-centre/find-a-media-release/2017-releases/17-285mr-day-trader-pleads-guilty-to-market-manipulation/

[2] http://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s1041a.html

[3] http://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s1041b.html

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