Back in 2013, the world’s biggest bitcoin exchange handled over 70% of all transactions in the cryptocurrency. The exchange was called Mt. Gox, and the future looked bright for the company.
But in February 2014, Mt. Gox suspended trading, closed its website, and filed for bankruptcy, saying that some 850,000 bitcoins had disappeared and had probably been stolen. Since then, the company has been mired in legal proceedings brought by creditors hoping to retrieve their funds.
Exactly what went wrong at Mt. Gox has never been clear. Rumors abound that the exchange was riddled with accounts that attempted to manipulate the price of bitcoins. But evidence of this activity has been hard to gather.
Today, that looks set to change thanks to the work of Weili Chen and colleagues at Sun Yat-sen University in China, who say they’ve uncovered evidence of serious market manipulation in the run-up to the exchange’s collapse in 2014. The discovery, they say, suggests that the cryptocurrency market desperately needs stronger oversight to prevent future manipulation and to reassure potential investors.
The team’s method is based on the network of transactions that took place at the exchange between April 2011 and November 2013. This data was mysteriously leaked online in 2014 and provides far more detail than is available from the blockchain record. It has been studied by various groups, but Chen and co are the first to analyze the network properties in this way.
To begin with, the team looked at each transaction to see whether the trade took place using roughly the same price that bitcoins were changing hands for more broadly. To their surprise, a significant number of trades took place at rates that were far higher or far lower than the reference price.
On August 30, 2013, for example, the going rate for bitcoins in general was between $129 and $143. But on the same day, Chen and co found one transaction in the Mt. Gox data in which a single bitcoin sold for $49,000, and another which sold for just $0.81.
Indeed, the team counted up all the trades in which the price was more than 50% higher or lower than the reference price and found almost 200,000 of them. That’s about 2.8% of the total number of transactions.
The sheer number of these transaction suggests they have a specific purpose. Chen and co say the most likely purposes are providing liquidity and boosting the volume of trading. But it doesn’t take a rocket scientist to see how this kind of activity might influence the bitcoin price too.
“Price manipulation is also a likely purpose,” say Chen and co. “We find that the abnormal transactions are greatly correlated with the Bitcoin exchange price.”
The researchers go further by studying the network that is formed when each user is a node and a transaction between them creates an edge. They then looked at pattern of trades between the 10,000 users who had been involved with abnormally high transactions, the 6,000 involved in low-priced transactions, and a group of 9,000 who were never been involved in an abnormal transaction.
The network analysis reveals some eyebrow-raising trends. For a start, the network of abnormal accounts is much more tightly clustered than the network for normal accounts. “One possible reason is that these accounts are controlled by one organization,” say Chen and co.
The team also looked at the transactions and accounts that had the greatest influence on the price. Abnormal accounts turn out to be much more highly correlated with that price than normal accounts.
These accounts also display some highly suspicious patterns of trade. For example, on February 7, 2013, account 231 made 749 transactions with itself. This makes no sense for an ordinary trader, but Chen and co have their own theory to explain it. “A reasonable explanation for the self-loop pattern is that the account may belong to the exchange and may be used to increase daily transaction volume or price manipulation,” they say.
Another suspicious pattern is a large number of trades from one account to another or between two accounts. For example, on April 14, 2103, account 231 bought and sold with another single account more than 150 times.
All this is highly suspicious. “These findings convinced us that there are many market manipulation behaviours in the exchange,” say Chen and co.
This analysis raises important questions for bitcoin traders and investors. In particular, they will want to know whether this kind of manipulation is still ongoing, and how it can be prevented.
Regulation could help but is not yet in place. Cryptocurrencies are not officially recognized as money by most governments. If they ever are, a whole new raft of financial regulation will apply that should make this kind of manipulation much harder. But until then, this kind of trading is likely to remain a Wild West.
Ref: arxiv.org/abs/1902.01941 : Market Manipulation of Bitcoin: Evidence from Mining the Mt. Gox Transaction Network