On June 8, it was reported that the U.S. Commodity Futures Trading Commission (CFTC) demanded extensive trading data from several cryptocurrency exchanges in order to investigate whether there has been price manipulation in the crypto market.

Earlier, on May 24, Bloomberg reported that a criminal probe into Bitcoin (BTC) and Ethereum (ETH) price manipulation by crypto traders had been opened by the U.S. Department of Justice (DOJ) in conjunction with the Commodity Futures Trading Commission (CFTC). That information was indirectly confirmed in the recent Wall Street Journal report, although it was made clear that the DOJ was studying potential price manipulation in a separate case. In May, some mainstream players, including former Wall Street executive and billionaire investor Michael Novogratz, and Cameron of Winklevoss twins, president of the Gemini exchange, greeted the probe.

What provoked the CFTC investigation?

According to the Wall Street Journal, the probe followed the launch of BTC futures by CME Group, a major derivatives marketplace, in December 2017. CME generates its BTC futures prices based on data from four major crypto exchanges: Bitstamp, Coinbase, itBit and Kraken, where manipulative trading could potentially have altered the value of BTC futures.

After the settlement of the first contract in January, CME asked the four exchanges to provide trading data. However, several of the exchanges refused to cooperate, saying that the request was intrusive. The crypto exchanges only handed over their data once CME shortened the time window of its request from one day to a few hours, according to the Wall Street Journal’s sources. It was also reported that CME originally sought the information through a third-party — a London-based company that calculates the Bitcoin price to use for its futures contracts. The sources added that the crypto exchanges did not want to hand over data to the undisclosed British firm, which also runs its own trading platform.

CME is regulated by the CFTC, a federal agency dealing with futures and options markets in the U.S. The CFTC views Bitcoin as a commodity and is therefore subject to its direct supervision.

Thus, regulators from the CFTC were allegedly upset that CME does not have agreements which obligate crypto exchanges to share price data that is related to futures contracts. According to the Wall Street Journal’s sources, the quarrel between CME and the crypto exchanges led the CFTC to open an investigation.

Nevertheless, CME spokeswoman Laurie Bischel said that their London-based index provider has a disclosure agreement with all four exchanges:

“All participating exchanges are required to share information, including cooperation with inquiries and investigations.”

Kraken Chief Executive Jesse Powell told the Wall Street Journal that the “newly declared oversight” of how BTC prices form futures prices “has the spot exchanges [Eds: spot markets are non-futures exchanges] questioning the value and cost of their index participation,” while other exchanges declined to comment or didn’t respond at the time.

The Wall Street Journal article also mentions that the CFTC is coordinating their investigation with the U.S. Department of Justice (DOJ). As mentioned above, last month the DOJ opened a similar — but separate — investigation into BTC and ETH price manipulation.

But how can one manipulate BTC price?

The Wall Street Journal’s article mentions ‘spoofing’ as one of the examples of illegal trading schemes that are investigated by CFTC. The May report regarding the separate criminal probe launched by DOJ also listed ‘wash trading’ in a similar context.

Spoofing is a process when a trader (or a group of traders) creates an order for a substantial amount of BTC (or any coin, commodity, etc.) to form the illusion of exchange optimism or pessimism — depending on their goals — and then cancels it, i.e. when someone puts an order to sell 2000 BTC, it might cause some panic among traders, rushing them to sell their stock before the price drops, effectively dropping that price as a result. That’s what an entity named Spoofy would do on Bitfinex, according to a detailed blog on Hackernoon.

Similarly, an article in the Journal of Monetary Economics published by a group of academics in early January, suggests that the price of Bitcoin was artificially bloated in 2013 by a single player operating on the largest exchange at the time, Mt. Gox (which then infamously shut down) and trader Sylvain Ribes published a Medium post in March, arguing that about $3 billion of all crypto-assets’ volume is trumped up.

Wash trading, in turn, is when a trader simultaneously sells and buys the same amount of BTC, essentially trading with himself. First, an investor will place a sell order, then place a buy order to buy from himself, or vice versa. Both activities, spoofing and wash trading, are illegal in the mainstream financial world, but it is worth noting that crypto markets are largely unregulated.

In theory, there are more ways to manipulate the price of BTC: the FICC Markets Standards Board (FMSB), the UK industry body overseeing standards in fixed income, currency and commodity trading, lists about 24 of them besides spoofing and wash trading.

Market and community reaction

On June 10, the day after the Wall Street Journal report, crypto markets saw a sharp drop, as all of the top-100 cryptocurrencies by market capitalization were in the red over 24 hours, while total market capitalization was down by about $20 billion over the same period.

John McAfee, founder of McAfee Antivirus Software and crypto enthusiast who recently announced his bid to run for U.S. president in 2020 as a way to serve the crypto community, urged the community to not panic about the price drop:

“It is an overreaction to the news that Bitstamp, Coinbase, itBit and Kraken are being investigated for price manipulation. This will delay the bull market by no more than 30 days. Don't buy into the fear. Buy the coins.”

While the CFTC probe into four major exchanges is considered to be one of the reasons for the price drop, it might have also been related to the mainstream media reports regarding the security breach of South Korean crypto exchange Coinrail. However, this event is unlikely to have significantly impacted the price action on the markets, with Coinmarketcap data showing that Coinrail is the 99th largest crypto exchange, with a rather modest trading volume of about $2.5 million. The community’s reaction on Bloomberg, the Wall Street Journal, Reuters, the Guardian and others claiming that Coinrail’s hack had crashed markets seemed frustrated.

In late May, BTC fell as much as 4.3 percent to $7,267 shortly after Bloomberg broke news about the DOJ and CFTC investigation on May 24 that the media outlet posted as an update a few hours after the original publication, which also prompted some community members to accuse the publication of FUD.