Cryptocurrency and market manipulation - Lexology

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Syed Rahman of Rahman Ravelli assesses the potential for market abuse by cryptocurrency exchanges and the approaches taken so far in the UK, European Union and US.
Cryptocurrencies have sparked plenty of debate in recent years. Much of this has been focused on either the value of them or their regulation. Yet the issue of market manipulation needs to be examined, particularly the conduct of cryptocurrency exchanges.
The late 2022 collapse of FTX has put crypto and market abuse firmly in the spotlight. At one point in its three-year existence it had been the third-largest cryptocurrency exchange by volume in the world. Now, FTX founder and CEO Sam Bankman-Fried is charged with offences including conspiracy to commit commodities fraud and securities fraud, and conspiracy to defraud the United States and commit campaign finance violations. The charges stem from allegations that Bankman-Fried defrauded investors out of $1.8 billion (£1.5 billion). FTX has been in Chapter 11 bankruptcy proceedings in the US since last November.
The large-scale, high-profile nature of FTX’s collapse has led to many questioning how crypto exchanges function and the risk of market manipulation – the attempt to artificially affect the price of an asset and / or the behaviour of markets. Market manipulation is certainly not unique to crypto exchanges. It is an illegal practice that has gone on for centuries. But Deloitte, in its 2021 report “Market Manipulation in Digital Assets’’ pointed out that market capitalisation for cryptocurrency had hit $1 trillion two years ago. It warned that up to 90% of trading could be vulnerable to market manipulation.
Market Manipulation Risk
The distributed ledger technology (DLT) involved in crypto trading allows for data to be distributed and synchronised. But it does not prevent market manipulation. There are a number of respected and well-regulated exchanges in the cryptocurrency sector. But there are many small exchanges that are less well known and less regulated. There are also many who are looking to use cryptocurrency as a vehicle for wrongdoing.
Market manipulation is one way in which crypto can be used to make illegal gains. Such manipulation can be carried out in a number of ways. Some employ tactics that have been used in more traditional asset markets while others are unique to cryptocurrency.
The most popular are:
Claiming Market Abuse – the UK and Europe
In the UK, market abuse is covered by the Criminal Justice Act 1993 (CJA) and the UK Market Abuse Regulation (UK MAR). Any claim would depend on the cryptocurrency meeting the definition of a security.
The Financial Conduct Authority’s FCA PS19/22: Guidance on Cryptoassets states that cryptocurrencies can be regarded as a security token. This could be taken to mean that such an asset could be considered a debt security under the CJA – and if it was negotiable on the capital market it would constitute a transferable security and, therefore, meet the UK MAR definition of a security.
Both of these outcomes would mean there were grounds for a claim for market abuse. But as cryptocurrencies are often traded across borders on platforms in various jurisdictions – and at great speed – the issue of enforcement can be problematic.
In 2022, the European Parliament approved the Markets in CryptoAssets (MiCA) regulation, which is likely to have a notable effect on the crypto market when it comes into force in 2024. Under MiCA, cryptocurrencies are divided into four categories: cryptoassets, utility tokens, asset-referenced tokens and electronic money tokens (e-money). They will be regulated in accordance with their classification. Any cryptocurrency that is traded on a cryptoasset trading platform operated by a cryptoasset service provider would be subject to the MiCA market abuse regime, which includes requirements regarding disclosure of inside information, prohibiting of insider dealing, unlawful disclosures and market manipulation. It remains to be seen if the UK takes steps to adopt a similar approach.
Claiming Market Abuse – the US
In the US, the situation regarding classification of cryptocurrencies is multifaceted. While the Internal Revenue Service (IRS) classes them as property, the Securities and Exchange Commission (SEC) treats them as securities, while the Commodity Futures Trading Commission (CFTC) views them as commodities. The Digital Commodity Exchange Act of 2022 was introduced to regulate trading venues and oversight is provided through state money transfer laws.
But the US is like the UK, in that there is no centralised cryptocurrency regulation. Yet the US Department of Justice (DOJ) and the SEC have brought their first insider trading case involving cryptocurrencies. The case saw Nikhil Wahi, brother of a former product manager at CoinBase Global, sentenced to 10 months in prison in January 2023 for trading using misappropriated information about cryptoasset listings on an exchange. The SEC had argued that nine of the cryptoassets involved met the definition of securities under federal securities law, which enabled it to bring the action for insider trading. The case can be seen as an indicator that the US authorities can and will bring civil claims and criminal charges when market abuse is suspected in relation to cryptocurrencies.
Conclusion
The developments so far in relation to the policing of cryptocurrencies are a reflection of the need to tackle the sharp practices and resulting volatility in the crypto markets. These developments have not – so far, at least – have moved as swiftly as events in the markets they relate to. But they represent an ongoing attempt to both reduce the scope for crypto-related market manipulation and hold to account its perpetrators.
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Criminal Justice Act 1987 (UK)
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