Bitcoin's Big Cleanup

(Bloomberg Opinion) -- Bitcoin and other cryptocurrencies make up just a tiny slice of the global economy. But that doesn’t mean regulators can ignore the wave of scams, fraud and market manipulation designed to snare gullible punters.

With U.S. law enforcers now probing trading practices such as “spoofing” — illegal and aggressive order cancellations designed to move markets — this looks very much like the beginning of a sustained crypto cleanup. Drawing investors back in, even with the promise of a less Wild West-style market, will take longer than cheerleaders expect.

Investigating possible price manipulation in these markets was a natural next step for the authorities, which have ramped up scrutiny of everything from new token sales to crypto-hedge funds in recent months. There’s plenty of data evidence to dig into, and the Commodity Futures Trading Commission and SEC have demanded information from a lot of companies.

There are the “pump-and-dump” chat rooms where traders take advantage of thinly traded digital currencies. Elsewhere, exchanges have been accused of being open to spoofing or so-called “wash” trading, where one entity buys and sells the same order. The popular Coinbase exchange faces allegations from clients of insider trading.

Of course, it’s natural to question the authorities’ track record of putting spoofers and manipulators behind bars, even those working in traditional financial markets. It’s a fairly recent phenomenon. The practice of spoofing was only made illegal in the U.S. in 2010, and the first conviction was in 2015. In January, the CFTC announced the creation of a new Spoofing Task Force to “root out” the practice. So there’s still no established model for building a successful anti-spoofing case — for example, what a jury would deem to be a suspicious level of order cancellations.

But the drive by law enforcers to dig into the crypto world and demand more transparency is here to stay. This can only dent the aura, and price, of Bitcoin. We don’t know the true “worth” of a cryptocurrency — although there are many wacky price targets — but there’s evidence that the price is closely linked to the ecosystem where it is traded. One recent research paper found that a near-tenfold rise in Bitcoin’s price in 2013 was driven primarily by two bots engaging in suspicious activity in a thin market.

The market today is very different, with more traders, more coins and more exchanges, but greater transparency is bound to have an impact. Bitcoin fell to its lowest price in more than a month after Bloomberg’s report on the U.S. criminal probe.

What happens next? Crypto-evangelists will no doubt argue that a better-maintained market is a healthy development, and one that will pave the way for the flood of institutional Wall Street money that always seems to be right around the corner. Plenty of market participants have been asking for more transparency. New crypto exchange Legolas, for instance, has criticized the incumbents as being opaque and vulnerable to manipulation.

Still, the idea that big risk-averse institutional investors will jump in just as authorities start to trawl the depths of this murky market seems fanciful. Speculation has been Bitcoin’s chief appeal, of course, but the necessary cleanup operation will drag on its price for some time to come.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

©2018 Bloomberg L.P.