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New Report from New York Attorney General’s Office Shows Crypto Exchanges Are Vulnerable to Manipulation

A ground-breaking report from the New York Attorney General’s Office on crypto markets was released earlier today. The report shows that major cryptocurrency exchanges are vulnerable to price manipulation.

The report also found that three exchanges – Kraken, Binance, and Gate.io – were particularly problematic. These exchanges have all been reported to the New York Department of Financial Services (NYDFS) for a further investigation into how they could be violating US law.

Price manipulation is one of the reasons the SEC has denied every bitcoin ETF proposal that has come across its table. The SEC feels that exchanges have an opportunity to manipulate crypto prices. Bitcoin ETFs, meanwhile, fail to offer adequate protection for retail and institutional investors against this price manipulation.

Earlier this year, we sent letters to major cryptocurrency trading platforms requesting key information on how they operate.

Today, we are releasing the results of that inquiry. Read our report: https://t.co/s4gcqEwvB8 pic.twitter.com/XhhHEqWOBY

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

The report from the New York Attorney General’s Office earlier today is the result of a months long investigation into crypto markets. The report found that many exchanges lack appropriate safeguards against price manipulation, and the lack of these safeguards is putting consumers at risk.

Based on the results of our report, we have also referred three platforms – Binance, https://t.co/UEMbx5VSWm, and Kraken – to the New York State Department of Financial Services for possibly operating unlawfully in New York.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

The New York Attorney General’s Office felt that these problems were so serious, in fact, that it referred three exchanges to the New York Department of Financial Services for possibly operating unlawfully in New York. Those exchanges include:

Binance is the world’s largest cryptocurrency exchange by trading volume, handling approximately $1 billion in cryptocurrency trades every 24 hours. Kraken is routinely in the top 15 or 10 exchanges by trading volume, while Gate.io currently occupies the #27 spot. The three exchanges represent a significant share of cryptocurrency exchange volume in the United States and worldwide.

Binance famously keeps its hands off of fiat currencies. Although Binance offers USD Tether trading, the company does not deal directly with the US Dollar. Kraken, meanwhile, does offer USD trading. In fact, the exchange’s top pairs include ETH/USD, BTC/USD, XRP/USD, and EOS/USD, among others.

Gate.io, like Binance, uses exclusively USD Tethers (USDT). Of the top 10 cryptocurrency pairs traded over the last 24 hours on Gate.io, all of them include USDT. ETH/USDT, EOS/USDT, and DOGE/USDT are the top three pairs, for example.

You can view the full report from the New York Attorney General’s Office here. Here’s how the Office introduced their “Virtual Markets Integrity Report”:

“Attorney General Barbara D. Underwood today announced the results of the Virtual Markets Integrity Initiative, a fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or ‘crypto' currencies like bitcoin and ether.”

The origins of this latest report date back to April 2018, when the Attorney General’s Office sent letters to 13 cryptocurrency exchanges requesting key information about their operations. The Office wanted to determine whether these exchanges had appropriate controls and safeguards to protect consumer assets.

The goal of the inquiry was to increase transparency and accountability across cryptocurrency exchanges.

Exchanges were asked to disclose the following information:

The Office also asked each exchange about their approach to handling suspicious trading and market manipulation, including the operation of bots on the platform, their limitations of use, and access to non-public trading information.

In addition to taking specific action against Binance, Kraken, and Gate.io, the New York Attorney General’s Office report focuses on three main problems across many major cryptocurrency exchanges, including:

The report found that virtual asset trading platforms:

First, many platforms have yet to implement serious efforts to monitor and stop abusive trading.

Few platforms seriously restrict, or even monitor, the operation of bots or automated algorithmic trading on their venue. pic.twitter.com/OUEr8w0SMH

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

On the contrary, many seem to cater to professional, automated traders—leaving retail customers at a disadvantage.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

“have yet to implement serious efforts to monitor and stop abusive or manipulative trading” and that “few platforms seriously restrict, or even monitor, the operation of bots’ or automated algorithmic trading on their venue.”

Some of the advantages that professional, automated traders have over other traders, for example, is access to high-speed direct data feeds. Some cryptocurrency exchanges also allow professional traders to “co-locate” or “cross-connect” their trading computers to the exchange’s servers.

The report also highlights the difference in fees that professional traders pay compared to retail investors.

“Those fee structures and services are designed to allow professional traders to leverage access and speed to power sophisticated automated trading strategies – strategies that can negatively affect the trading performance of everyday, non-automated customers.”

Second, there are pervasive conflicts in interest.

Customers need to understand whether and how trading platforms address these conflicts, and how platforms protect everyday traders from consequent disadvantage.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

The SEC has denied multiple bitcoin ETFs because of perceived conflicts of interest in the space. The report from the New York Attorney General’s office similarly finds that there are “pervasive conflicts of interest” within today’s top cryptocurrency exchanges.

“The report finds that virtual asset trading platforms engage in multiple, overlapping lines of business that present serious conflicts of interest.”

Some exchanges, for example, trade on their own exchange “in volumes that constitute a significant portion of total trading.”

Other exchanges “allow their own employees to trade on their venue” and don’t prevent employees from accessing “non-public information to gain an advantage over other traders.”

“A few platforms issue their own virtual currencies or accept compensation in exchange for listing a virtual asset to trade.”

Binance, for example, reportedly charges as much as $6 million to list a token on their exchange. Binance also issues its own native token, BNB, which has faced controversy.

The final major problem identified in the report is that cryptocurrency exchanges have limited protection of customer funds.

Third, customers have limited protection for their funds.

Generally accepted methods for auditing virtual assets do not exist, and trading platforms lack a consistent and transparent approach to independently auditing the virtual currency that is purportedly in their possession.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

Obviously, when an exchange doesn’t have an independent auditing procedure, there’s a risk that the exchange doesn’t have any virtual currency whatsoever.

If a hack or unauthorized withdrawal occurs, customers are also highly exposed. Unlike FDIC insurance, there's no public protection to cover virtual currency losses. There are serious Qs about the scope and sufficiency of the insurance some platforms carry to cover those losses.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

Some platforms do not insure against losses at all.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

Eventually, like Mt. Gox, it will be revealed that many exchanges don’t have the funds to cover all customer withdrawals at the same time. There will be a run on an insolvent exchange, and this could trigger a Mt. Gox-like collapse in virtual currency prices. This is one of the risks highlighted by the latest report.

Binance, Kraken, and Gate.io seemed to be the worst offenders in the report. However, the investigation focused on 13 different cryptocurrency exchanges – including famously regulated exchanges like Gemini.

The cryptocurrency exchanges from the report include Bitfinex, bitFlyer USA, Bitstamp, Bittrex, Coinbase, Gemini, HBUS Inc., itBit, Poloniex, and Tidex.

An additional four cryptocurrency exchanges were contacted by the New York Attorney General’s Office but declined to answer, claiming that they did not allow trading from New York. Those exchanges included Binance, Gate.io, Huobi Global Limited, and Kraken. The report shows that Binance, Gate.io, and Kraken all accepted trades from within New York State, while Huobi did not.

Ultimately, it’s no secret that major cryptocurrency exchanges give preferential treatment to high-volume, algorithmic traders. It’s also unsurprising to see the report found conflicts of interest within major cryptocurrency exchanges.

Based on the results of our report, we have also referred three platforms – Binance, https://t.co/UEMbx5VSWm, and Kraken – to the New York State Department of Financial Services for possibly operating unlawfully in New York.

— NY AG Underwood (@NewYorkStateAG) September 18, 2018

That’s why the most serious and surprising part of this report is the fact that the New York Attorney General’s Office found that Binance, Kraken, and Gate.io were engaging in particularly problematic practices – problematic enough to warrant a report to the New York Department of Financial Services for potentially violating the law in New York.

We’ll keep you posted on this story as it unfolds.

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