Bitcoin Manipulation? Buyer Beware!
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As a subscriber you can listen to articles at work, in the car, or while you work out. Subscribe NowBitcoin’s large price swings during the last five years provided some investors with astronomical returns and others with similar losses. A recent study suggests this dramatic price fluctuation might have been intentional and caused by the manipulative practices of one large cryptocurrency player.
Quick Refresher
If you’re still trying to make sense of cryptocurrency and Bitcoin, here’s a quick refresher. Cryptocurrency isn’t physical tender like the $20 bill in your wallet. It’s a digital currency, not issued or backed by a bank or government, that uses a decentralized network. That network is based on “blockchain” technology, a distributed ledger enforced by a massive network of computers. Balances and all other transactions are kept on this ledger which is secured using cryptography.
Bitcoin, the world’s largest cryptocurrency by market cap, was created in 2009. It gained popularity by promising lower transaction fees than traditional online payment methods. Users and investors also liked its independent status, i.e., it isn’t controlled by a central authority like a bank or government-issued currency. Also, it’s impossible to double spend a Bitcoin and there are only a finite number of Bitcoins in the world.
What Caused the Huge Value Swings?
As Bitcoin surged in popularity, so did its price….briefly. From March 2017 to March 2018, the price of one bitcoin rose from around $1,200 to over $19,200 at its peak. Then it took a deep dive to under $7,000 by March 2018.
This large price fluctuation was intriguing because Bitcoin itself didn’t do anything to warrant such value swings. The price fluctuations were widely accepted as an indicator of demand. However, a recent forensic study by finance professors John Griffin and Amin Shams, instructors at the University of Texas and Ohio State University respectively, suggests manipulation may have been the cause for these massive swings.
The study doesn’t definitively conclude who manipulated Bitcoin, rather it suggests that a large crypto exchange either aided or knew about the scheme while it was happening. The study also claims the manipulator used a secondary cryptocurrency called Tether to execute its plan.
Tether is similar to Bitcoin but with one key difference: Bitcoin is traded freely and Tether’s value is pegged to the U.S. dollar via an asset reserve, otherwise known as a “stablecoin”. For every Tether in circulation, there should be $1 in the reserve.
The study suggests Tether wasn’t always fully backed by reserves as advertised. The stablecoins were “printed” without sufficient backing, resulting in more coins being circulated than warranted. When these “additional” coins were used to purchase Bitcoin, it drove up Bitcoin’s price.
Furthermore, Griffin and Shans found a pattern in the research that displayed Tethers flowing through tightly clustered pathways among various exchanges in route to being traded for Bitcoins. These pathways originated from one large account at the crypto exchange, which indicates control by a single entity. The exchange has denied any wrongdoing and challenged the legitimacy of the study. Time will tell.
So, What Are the Implications?
There are two key tests a currency must pass to be considered a viable everyday method of transaction.
- First, you shouldn’t be able to “double spend” it. Bitcoin initially passed this test and that status remains unchanged.
- Second, to be viable, the currency must be viewed as safe, liquid and secure. For someone to willingly accept your cryptocurrency, he or she has to believe it won’t vanish overnight and its value won’t drop significantly. Whether Bitcoin passed this test is still debatable given the value swings cryptocurrencies have experienced. However, the growing concern of manipulation reduces their viability as a widely accepted transaction method.
You’ve probably heard the technology behind cryptocurrencies referred to as “the future.” That sounds promising, but should you consider investing?
Here’s one important fact to note: Owning a cryptocurrency isn’t like owning a technology stock. With a technology stock, if the company fails you own the patents, software and other assets. Unfortunately, you don’t own any of the technologies behind Bitcoin or other cryptocurrencies.
Summary
Cryptocurrency still has a long way to go before it is accepted as an everyday form of payment. At this point, it’s best to view cryptocurrency as a highly speculative investment rather than a currency. Anyone investing must do so with the understanding that all could be lost and that the price fluctuations may not be triggered by anything that can be anticipated or quantified.
Anthony Harcourt is a Portfolio Manager at Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. For more information, visit their website or email Anthony.