Bitcoin may be the new frontier of money, but it’s still vulnerable to the kinds of scams that have plagued financial markets for decades. And now it looks as if the government is cracking down more aggressively.
The Justice Department has begun a criminal investigation into whether traders have manipulated the price of bitcoin and other digital coins, Bloomberg reported on Thursday, citing four unnamed sources.
Bitcoin traders clearly viewed the news as a negative, with the price falling to $7,400 from $7,558 within an hour of the report’s publication. The price has since rebounded back to $7,550.
The Justice Department, according to Bloomberg, is working with the Commodity Futures Trading Commission, which oversees futures and options markets. It’s not clear if regulators are also talking to CME Group (CME) or Cboe Global Markets (CBOE), both of which began offering bitcoin futures products last year. CME declined to comment, and Cboe did not immediately respond to a request for comment.
The Securities and Exchange Commission and Justice also would not comment, nor would the CFTC, which could “neither confirm nor deny an investigation.”
The SEC has already been cracking down on creators of digital currencies who regulators say are defrauding investors. And other agencies have been scrutinizing the industry for months. The CFTC has reportedly subpoenaed a top exchange called Bitfinex, though a spokesman for Bitfinex said he did not believe the investigation revealed on Thursday is connected to that exchange.
Bitcoin was designed to avoid regulation, because it’s an asset that gets traded globally R12; a kind of software that works simultaneously on computers all over the world. And yet, countries have laws against fraud that they can use to prosecute people manipulating markets even when those markets are technically off the grid.
People involved in cryptocurrency trading have been complaining about abuses for months, even as millions of curious new investors began buying into the craze.
“All the worst abuses of the stock market pre-Glass Steagall are currently rife within crypto,” Emma Channing, now the general counsel at Initial Coin Offering advisory firm Satis Group, said in an interview last year. “If we are going to see institutional finance come in at the pace I would like to see it, we have to clean house before the regulators are going to do it.”
According to the Bloomberg report, investigators are looking at manipulation schemes that have been used in stocks for years, including spoofing, which involves creating fake buy or sell orders to fool other traders into reacting. Once the price starts moving, the original trader cancels the orders. Other schemes involve self-dealing.
Regulators have made headway at reducing that kind of manipulation in traditional markets. But while they can put a ring fence around stock trades, enforcing stringent laws at exchanges, digital coins can’t be so easily corralled. Bad actors can simply move to unregulated exchanges where they can continue to trade and cause prices for those coins to swing on a global basis. That in turn can impact futures markets, which are supposed to be more heavily regulated.
Some entrepreneurs are watching warily — but hopefully — to see where the investigation leads.
“We believe regulatory oversight on the crypto-ecosystem is a long-term positive for all stakeholders involved,” wrote Rohit Kulkami, in an email to Barron’s. Kulkami is a managing director in charge of private investment research at Sharespost, a San Francisco company that is building a trading platform for digital coins that have been designed to operate as securities. “Despite the huge potential of the Blockchain technology, cryptocurrencies and the ICO process has to go through several hurdles before being widely accepted. We view the recent regulatory scrutiny on ICOs and crypto- trading practices to lay out rules to prevent fraud and protect investors as a step in the right direction. However, long-term uncertainty around regulatory environment can become an enemy of innovation and capital formation.”
Bitcoin’s initial slump on news of the investigation did not surprise Thomas Lee, managing partner at Fundstrat and one of the most outspoken bitcoin bulls in the traditional financial world.
“These stories have pressured the crypto market, as regulatory action (and related headline risk) reduces risk appetite and also is a further deterrent for near-term inflows from new investors,” he wrote in a note to clients. “However, these actions signal that adult supervision is coming to crypto and adding such oversight incrementally improves the structural integrity and legitimacy for crypto-currency investor. In other words, in order for institutional investors to be more actively engaged in crypto markets, such adult supervision is a necessary precondition.”
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