Bitcoin and other cryptocurrencies have seen dramatic but volatile price surges during the past year. But this month their billions in estimated market value are eroding, amid widening suspicions against one trading platform, a half-billion-dollar heist from another exchange, and an awakened global regulatory community. Warnings are on the rise from regulators, researchers, banking executives—and even crypto-insiders—that the value of these virtual currency holdings may be a mass illusion, because the market is so easily manipulated.

These sentinels point to a variety of gambits and players that can influence the perceived value of bitcoin and other digital coins. The possible culprits range from purveyors of fraudulent initial coin offerings (ICOs) to coordinated botnet traders that pump up prices to lure inexperienced investors to buy, and hackers who can make millions of dollars by stealing coin deposits.

The motives for market manipulation could be as murky and intricate as the network of unsupervised entities that create digital coins, deal in them—and share only some of the transaction details with the public.

China has been cracking down on cryptocurrency exchanges, and signs that South Korea might also ban trading further rattled the market for digital coins. (South Korea’s finance minister denied such plans on Wednesday, Reuters reported.) The current mood runs against an optimistic narrative among fintech investors who saw cryptocurrencies going mainstream during 2017 as their market cap rose to about $600 billion. Investments in the bitcoin ecosystem of startups and service providers have come not only from specialist VC firms such as Blockchain Capital, but also from mainstream Silicon Valley firms including Andreessen Horowitz, which backed digital currency trading platform Coinbase.

Banks are among the companies interested in the blockchain technology underlying virtual currencies, but bank executives are also sounding warnings. This month, former Wells Fargo CEO Dick Kovacevich called bitcoin a “pyramid scheme,” CNBC reported. While bullish on cryptocurrencies in a December interview with Xconomy, F-Prime Capital partner David Jegen also said he expected U.S. regulatory agencies to step up oversight and enforcement in 2018.

Suspicion is now focusing on the integrity of record-keeping at the largely unregulated cryptocurrency exchanges. Most recently, the mainstream press has picked up on concerns shared over social media that the digital coin trading platform Bitfinex may have taken part in complicated maneuvers to prop up the bitcoin price. The fear circulating among the crypto-cognoscenti now is that if the alleged scheme unravels, the value of bitcoin could crash. Bitfinex is one of the decentralized exchanges whose trading reports influence the perceived value of bitcoin.

The U.S. Commodity Futures Trading Commission sent subpoenas on Dec. 6 to Bitfinex and a related company, Tether, which claims that the value of its coins issued under the same name is pegged to the value of the U.S. dollar, Bloomberg reported Tuesday, based on an unnamed source. Doubts have arisen that Tether maintains the dollar reserves to back up its coins, which have reportedly played a role in reassuring investors that they could redeem their investments in bitcoin and other digital coins by receiving dollars in return.

On Tuesday, the bitcoin exchange rate fell through a $10,000 floor that had held since November.

Public alarms about Bitfinex have been streaming from an anonymous Bitfinex user called Bitfinex’ed, who communicates his or her suspicions through blog posts, tweets, and YouTube videos, according to the U.K. publication Express in a story Monday headlined “Bitcoin price CRASH ‘BLOODBATH’’’ Educated observers of the cryptocurrency landscape, such as a U.C. Berkeley computer science professor and a Unix system administrator, told the Express that Bitfinex’ed has real cause for concern. But such individuals can’t insist on an audit of entities such as Bitfinex and Tether.

What can investors believe?

The CFTC has issued warnings about the trading practices and price volatility in the largely unregulated markets for cryptocurrencies. The SEC has blocked questionable initial coin offerings and issued its own warnings. But so far, U.S. regulators haven’t established a comprehensive regulatory scheme that would monitor for fraud and police trading in digital coins.

Facebook on Tuesday announced a ban on advertising for all cryptocurrencies and ICOs as part of its broader policy to weed out misleading or deceptive promotional practices. The company says it may let some cryptocurrency ads through in the future if it can learn how to distinguish between fair and false statements about them.

Like stock market investors, digital coin buyers decide what to pay based on reports from exchanges and data firms about the going exchange rates in current purchases. But what if some of those transactions never happened, or not at the prices claimed?

Observers of the cryptocurrency world are finding patterns that remind them of characters like convicted Ponzi scheme operator Bernie Madoff and the “pump-and-dump” mastermind dubbed “The Wolf of Wall Street” in a Hollywood film.

This might be a limited worry if bitcoin purchases were still the domain of the tech kids’ treehouse they began in. But bitcoin and other cryptocurrencies are becoming integrated into the conventional financial system, a group of academic researchers warned in an analysis that has fed the current uneasiness.

“As mainstream finance invests in cryptocurrency assets and as countries take steps toward legalizing bitcoin as a payment system (as Japan did in April 2017), it is important to understand how susceptible cryptocurrency markets are to manipulation,” the group of professors wrote in a recently published study of suspicious trading on the Mt. Gox bitcoin exchange, which they linked to a steep spike in bitcoin’s exchange rate in 2013.

Mt. Gox—a cautionary tale

That study provides a rare inside peek at the realities behind the Wild West cryptocurrency market. The academic researchers analyzed a trove of leaked data from the Mt. Gox exchange, which was formerly the dominant exchange for bitcoin transactions. Mt. Gox collapsed in 2014, raising suspicions of stolen coin deposits, an insider cover-up, and fraudulent trading.

Mt. Gox is now the record-setter that all cryptocurrency exchange failures are measured by.

The researchers found evidence that a series of questionable or fake trades—possibly by a single person—boosted the exchange rate of bitcoin-to-dollars across all major trading platforms by at least 560 percent over two months in late 2013, from $150 to more than $1,000. At the time, such a surge was unprecedented for bitcoin since its introduction in 2009.

“We found clear evidence that the first meteoric rise in Bitcoin prices that took place in 2013 was likely driven by fraudulent trades,” says Tyler Moore, one of the co-authors of the research paper, “Price Manipulation in the Bitcoin Ecosystem,” published in the Journal of Monetary Economics.

What’s more, the overall trading volume also spiked beyond … Next Page »

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Bernadette Tansey is Xconomy’s San Francisco Editor. You can reach her at btansey@xconomy.com. Follow @Tansey_Xconomy

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