In May 2023, a former Coinbase employee named Ishan Wahi made history as the first person to be jailed for insider trading involving cryptocurrency. Wahi had tipped off associates about crypto assets that were being added to the exchange, enabling them to make profitable trades before the listings were made public.
Even before this headline case, regulators around the world were looking at how abuse of the crypto markets could be curtailed. At the international level, the International Organization of Securities Commissions (IOSCO) finalized standards last year for digital and crypto asset markets to ensure that they can identify and prevent market abuse. These international standards are already being implemented at the national level.
The UK’s proposed financial services regime for cryptoassets includes the introduction of compulsory systems and controls to prevent and detect market abuse for crypto trading companies. Regulated crypto firms would also have to disclose inside information and lists of insiders to authorities. IOSCO Fintech Task Force Chair Singapore has also consulted on similar market integrity measures. In the EU, the market abuse rules that form part of MiCA, the Markets in Crypto Assets regulation, explicitly prohibit market manipulation and insider dealing. detect and prevent unfair trading practices
But there is much still to be done. Below we outline some of the main typologies of market manipulation that continue to plague the crypto ecosystem, and what can be done to detect and combat them.
Wash Trading
Wash trading involves creating the false appearance of market demand activity through buying and selling the same asset between related parties to give the impression of popularity.
A significant fixture of NFT and crypto-token launches, wash trading accounted for some USD 2 billion in value since 2020, according to one recent estimate. A particularly eye-catching example occurred in 2021, when a Cryptopunk NFT sold for around USD 500 million. It later transpired that the buyer and seller was one individual, who made the trade using borrowed cryptocurrency that they immediately repaid, known as a flash loan.
The graph below illustrates a typical NFT wash trading scenario, in which one individual owns two wallet addresses. Within a 24 hour period, the two wallet addresses send the same NFT (“Moonk”) back and forth between each other to create the appearance that the NFT is in high demand. Top-line NFT statistics may indicate it has been traded over a dozen times in a short period, when in reality, blockchain intelligence reveals that the trades were illusory.
Wash trading has also attracted law enforcement attention, most notably when in December 2022 the SEC charged leaders of Alameda Research and FTX with manipulating the price of FTX’s FTT Token “by purchasing large quantities on the open market to prop up its price.”
By detecting circular movements of funds between linked addresses, blockchain analysis can give an indication of whether the price of a cryptocurrency or token is likely to have been inflated through wash trading.
Oracle Manipulation
Oracle manipulation is a DeFi practice that involves tampering with the authority that determines a token’s value, known as the price oracle.
Perhaps the most notorious example of this practice occurred in October 2022, with the manipulation of the price oracle at the Solana-based platform Mango Markets. Through leveraged purchases of Mango tokens that subsequently shot up in value and were later used as collateral for loans, the crypto trader Avraham Eisenberg and his associates succeeded in making USD 115 million at the expense of other token holders.
Although Eisenberg defended his actions as a “highly profitable trading strategy” rather than a hack, he was eventually arrested and charged by the SEC with violating anti-fraud and market manipulation provisions of the securities laws. Eisenberg was later also sued by Mango Markets to return his remaining USD 47 million plus interest.
Insider Trading
As with its conventional counterpart, crypto insider trading involves using material non-public information to buy or sell digital assets ahead of market moving events. One such example is buying a large number of tokens prior to a public exchange listing announcement and profiting from subsequent price rises.
Clearly unethical but long a legal gray area, insider trading behavior in crypto has been generally targeted by law enforcement under the scope of adjacent offenses such as wire fraud and money laundering. However, SEC Chair Gary Gensler’s 2023 description of most cryptocurrencies as unregistered securities that should be subject to the same rules further emboldened investigators.
For example, in June 2022 a former employee of an NFT marketplace became the first individual to be charged with wire fraud and money laundering in connection with a scheme to commit insider trading in NFTs by using confidential information about what NFTs were going to be featured on the exchange’s homepage. Others have since faced similar charges.
Pump and Dump Schemes
Pump and dump schemes involve the coordinated promotion and purchase of a cryptocurrency or token to artificially inflate its price and attract buyers. Once the price has reached a certain level, a sell-off by the instigators results in the price crashing, cheating unsuspecting investors. Such schemes are devised and promoted in deep web and dark web chatrooms as well as on Telegram channels.
Blockchain intelligence tools can identify signs of pump and dump activity when a previously little-traded digital asset experiences sudden and vertiginous spike in price growth and trading volume. As many such schemes are promoted in online forums such as Discord and social media apps, open source analysis can also help identify whether the asset is being advertised by unknown or disreputable influencers and personalities.
To Combat, Collaboration is Key
Detecting market abuse is a team effort. To succeed, blockchain intelligence must be layered with open source research as well as off-chain trade data held by VASPs, regulators and other bodies.
Such joined-up thinking has already shown to have an impact. Virtual asset service providers (VASPs) in countries with full licensing and supervision regimes have lower rates of illicit activity than those in less regulated jurisdictions. This is according to a recent analysis by TRM Labs of crypto policy developments in 21 jurisdictions representing some 70% of global crypto exposure. In 2023, 80% of these jurisdictions have moved to tighten crypto regulations.
Close collaboration between VASPs, analytics companies and public institutions can enable manipulation to be spotted and acted on as early as possible, before the funds in question are able to exit the crypto ecosystem.
