One of the recurring themes in the socio-political experiment that is bitcoin is how the cryptocurrency community has slowly accepted norms and strictures that govern the fiat money system bitcoin was invented to supersede. As traders slowly grasp the scope of manipulation and grift that accompanies such an anarchic, anything-goes market, some have clamored for rules that might make the world of bitcoin as fair as it is free, from anti-money laundering safeguards to deposit insurance. Innovation recapitulates regulation.
FT Alphaville's Izabella Kaminska highlights the most recent such episode of this saga in the travails of Daniel Masters, founder of the Global Advisors Bitcoin Investment Program. In Masters' latest investor bulletin, he recounts how his fund got knocked ten percent from its benchmark by a competitor practicing textbook price manipulation. He writes:
The matters set out above highlighted another issue with bitcoin trading, which up until this point we had not considered. After the price drop, one player emerged as totally dominant in the open interest of the futures contract. It seemed pretty clear to us as a result that this event was not just a normal version of a large liquidation, with which we are familiar, but was a premeditated attack. When the dust settled, one unidentified player was short well over half the open interest.
In a typically regulated market like, say, lean hog futures, position limits established voluntarily by exchanges (and later mandated by Dodd-Frank) would keep a market participant from amassing such a dominant, price-shifting position. But the techno-utopia of bitcoin trading refuses to shackle its citizens with these kinds of outdated contrivances. And for Masters, that's kind of a bummer:
We would therefore class this episode as clear market manipulation, and in fact it was not just momentary: for many days thereafter the basis was so weak that it seemed that the one attack was being followed up by periodic smaller attacks. As such we approached the exchange. They confirmed to us that there were no position limits whatsoever and that people were free to do whatever they wanted in their “happy trading environment” (yes, they used those actual words). We made it very clear that such activity, whether in a regulated environment or not, might amount to criminality in Hong Kong and would certainly do so in many other jurisdictions. Following a number of discussions, the exchange encouraged the ‘rogue’ player to withdraw and things have now normalized.
Clearly, one man's “happy trading environment” is another man's viper pit, which is the ultimate tradeoff with bitcoin investing. You get all the excitement and arbitrage opportunity of a relatively prehistoric market without the safeguards of the current one.
Of course, we're talking bitcoin exchanges here, not bitcoin's central coding community. Though exchange operators seem to have some of the same libertarian leanings as the currency's diehard core (see above), they also have incentives like making money and staying out of jail. Regulators tend to treat bitcoin trading as a commodity, which subjects it to a basic set of rules and safeguards that exchanges must follow. But regulatory pressures are less interesting that those stemming from the bitcoin community itself.
When OTC markets backfire, bitcoin edition [FT Alphaville]