Cryptocurrencies: Market manipulation a rising fear

When members of the Hunt family tried to corner the silver market in the 1970s, the ultra-wealthy Texas clan reportedly flew their holding of 35 million ounces of the precious metal to Switzerland in a chartered plane under the watchful eye of armed Texas ranch hands. By contrast, manipulating the fast-growing market for cryptocurrencies requires just the click of a mouse.

Market observers have been raising red flags about the integrity of the market for bitcoin, ethereum, ripple and other types of digital money in recent months, given the meteoric rises in their prices. But worries about market manipulation are coming into sharper focus during the recent gut-wrenching decline in prices before rebounding on Wednesday.

"As I write this, [bitcoin] is below $10,000 and down almost 50 percent from a month ago," Brad McMillan, chief investment officer for broker-dealer Commonwealth Financial Network, said in a recent note. "While this is still almost double its value from three months ago, the change in trend in the past month is remarkable. The chatter is that this is normal for bitcoin -- and normal for January."

A recently published academic paper in the Journal of Monetary Economics found that a single trader likely drove the price of bitcoin from $150 to $1,200 during a two-month period in 2013 on the Mt. Gox Exchange. Mt. Gox collapsed a year later after a theft of $460 million was discovered.

According to the researchers, much of the manipulation at Mt. Gox was caused by two bots named "Markus" and "Willy" that seemed to be performing valid trades but didn't actually own any bitcoin. Markus began fraudulently acquiring about $76 million worth of the digital currency between Feb. 14, 2013, and Sept. 27, 2013. "Willy" began operating a few hours after "Markus" became active and went on to acquire around 600,000 bitcoins worth around $112 million through November of that year.

During his recent fraud trial in Japan, Mt. Gox CEO Mark Karpeles admitted that Mt. Gox operated "Willy."

"He wouldn't buy [bitcoin] on every single day," said Tyler Moore, an assistant professor of cybersecurity and information assurance at the University of Tulsa who was one of the report's authors. "He would buy on some days and not on others."

One the days he bought, the cryptocurrency's price went up around $20 as market participants viewed it as a signal to buy, and the price remained flat on days that he stayed on the sidelines, Moore said.

In a letter released last month, The Futures Industry Association, a trade group, raised questions about the Commodity Futures Trading Commission's (CFTC) plans to authorize bitcoin futures contracts, saying "we remain apprehensive with the lack of transparency and regulation of the underlying reference products … and whether exchanges have the proper oversight to ensure the reference products are not susceptible to manipulation, fraud, and operational risk."

Since the FIA's concerns were raised, futures contracts backed by CME Group, the world's largest  futures exchange, and its rival CBOE Global Markets have begun trading. Volume on both exchanges has been thin, which makes them vulnerable to manipulation.

CME's bitcoin contract recently showed trading volume of 2,357, while CBOE's three contracts showed a combined volume of 13,667. By contrast, volume for gold futures set to expire in February, was nearly 309,000 on the CME, while January corn futures showed trades of  nearly 194,000 contracts. A spokeswoman for the FIA declined to comment beyond its previous statements. The CFTC noted that it has issued advisories to investors about the potential pitfalls of investing in cryptocurrencies.

"Nobody knows for sure whether it's manipulated or not, but it's highly likely that there is manipulation happening," said Aaron Shapiro, who runs the digital marketing firm Huge, an adviser to companies on emerging technologies.

"There is no regulation, unlike all other commodities that are traded," Shapiro said. "The ownership of bitcoin is very highly concentrated. ... A thousand people own half of the outstanding bitcoin. When you have such a high concentration, it's very easy for insiders to manipulate the currency for their own benefit."

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    Jonathan Berr is an award-winning journalist and podcaster based in New Jersey whose main focus is on business and economic issues.