Market manipulation
107. In its written evidence to the Committee, the FCA highlighted the risk of price
manipulation in the crypto-asset market:
Because of the […] dynamics of crypto-asset markets, where trading
volume and capitalisation is considerably lower than established financial
markets, there is a greater potential for malicious actors to coordinate price
manipulation—such as ‘pump and dump’ schemes.
This presents a risk for
any potential buyers—retail or institutional—who may interpret sudden
price appreciation as a sign of a high quality crypto-asset with strong
potential, only to lose their money as these price rises are reversed.147
The FCA also noted the risks of other forms of market abuse:
The relatively immature market infrastructure underpinning the cryptoasset market could lend itself to more complex forms of market manipulation
such as insider trading or spoofing orders—the latter enabled by the lack of
reporting standards and the overreliance on non-professional websites for
price or market information.148
The FCA indicated that these risks are exacerbated by the difficulties of policing cryptoasset markets, even if they had the powers to do so:
[T]here would be practical difficulties policing market abuse in many
crypto-assets, even with the requisite powers, since much of the exchange
trading is concentrated in non-EU jurisdictions, and identifying the underlying owners of crypto-assets, who may hold ‘inside information’ or
those malicious actors spreading false information may be hampered by the
virtual and, in part, anonymised nature of these assets.149
108. An example of market manipulation of the price of Bitcoin was highlighted in a
paper by academics at the University of Texas, published on 25 June 2018.150 The paper
investigated whether Tether, a digital currency pegged to the US dollar, influences the
price of Bitcoin and found that:
Purchases [of Bitcoin] with Tether are timed following market downturns
and result in sizable increases in Bitcoin prices. Less than 1 per cent of
hours with such heavy Tether transactions are associated with 50 per cent
of the meteoric rise in Bitcoin and 64 per cent of other top cryptocurrencies
.
[…] These patterns cannot be explained by investor demand proxies but
are most consistent with supply-based hypothesis where Tether is used to
provide price support and manipulate cryptocurrency prices.151
109. In its written evidence to the Committee, Crypto UK noted that the current lack
of regulation of crypto-asset exchanges “create[s] an environment where there is a risk
to consumer manipulation.”152 Thus Crypto UK argued that pro-actively introducing
regulation of crypto-asset exchanges means that “[the] Government can pre-emptively
protect consumers against market abuse and exploitation.”153
110. One of the FCA’s three objectives is to “protect and enhance the integrity of the
UK financial system.”154 The FCA argued that “the markets need to be supported by
resilient infrastructure, with appropriate access and transparency to meet the needs of the
consumers, corporates and other wholesale clients that use them.”155
The FCA therefore
seeks to ensure that senior management are accountable for the capital market activities,
there is a positive culture of proactively identifying and managing conflicts of interest, and
firms’ business models, activities, controls and behaviour maintain trust in the integrity
of markets and do not create or allow market abuse, systemic risk or financial crime.156
111. Crypto-asset markets are particularly vulnerable to manipulation, and they fall
outside the scope of market abuse rules. In responding to this Report, the FCA should
outline the approach it would take to market manipulation were these markets to fall
within its remit.
Risks to financial stability
112. In March 2018, the Bank of England’s Financial Policy Committee “judged that
existing crypto-assets did not currently pose a material risk to UK financial stability.”157
Martin Etheridge, Head of Note Operations at the Bank of England, elaborated on the
Bank of England’s position:
From the Bank’s perspective, the primary lens through which we look
at this is one of financial stability. […]
[Crypto-assets] are not currently
functioning in payments and settlement, so that is not a particular worry.
In terms of the linkages with systemically important firms or systemically
important markets, right now, those linkages are pretty negligible. The
market itself is small in comparison to other large financial markets. In
terms of the activities of UK firms, that is also pretty small.158
The Bank of England also emphasised this in its written evidence, noting that “since the
peak on 6 January 2018, the crypto-asset market has lost 65 per cent of its value in just 12
weeks […]. Despite this fall, there has been no disruption to the financial system.”159
113. Mr Etheridge said that this view is shared by regulators globally:
[This] is also a position shared by our counterparts overseas as part of the
Financial Stability Board, which has reported to the G20 that it does not
currently believe there are material threats to global financial stability.160
114. The Bank of England is taking precautionary measures to ensure crypto-assets do
not become a risk to financial stability and Mr Etheridge informed the Committee that
the Bank of England is “stepping up […] monitoring activity […] [and] will be monitoring
the extent to which there is additional take-up for these asset classes.”161
115. Furthermore, Sam Woods, the Deputy Governor for Prudential Regulation and
Chief Executive Officer of the Prudential Regulation Authority (PRA), wrote to the CEOs
of banks, insurance companies and designated investment firms on 28 June 2018, noting
the risks crypto-assets pose and the regulator’s expectations:
Crypto-assets have exhibited high price volatility and relative illiquidity
[…] raise concerns related to misconduct and market integrity [and] may
appear vulnerable to fraud and manipulation, as well as money laundering
and terrorist financing risks. […] I remind you of your firm’s responsibilities
[…] to (i) act in a prudent manner; (ii) have effective risk strategies and
risk management systems; and (iii) deal with regulators in an open and
cooperative way […]162
116. The Committee agrees with the Bank of England that, since they are not being
widely used as a means of payment, and the linkages to systemically-important firms
and markets are negligible, the risk to financial stability arising from crypto-assets is
low. The Committee expects the Bank of England and the FCA to continue to monitor
developments in crypto-asset markets, and financial institutions’ exposure to them.
Advertising and investor protections
117. Both ICO issuers and crypto-exchanges use advertisements, including on social
media, that highlight the potential for quick returns on investments in crypto-assets.
Because neither ICO issuers or crypto-exchanges are regulated, these advertisements are
not subject to the FCA’s rules, nor does the regulator have any powers to withdraw a
misleading advert. For example, Coinshop, a website that enables users to buy Bitcoin
and Ethereum, advertised its services in Easy Jet’s inflight magazine in May 2018 stating
that “in 2017 we’ve witnessed the Bitcoin rise from $1,000 to $19,000—a 1800 per cent
increase. Millionaires, top level CEOs and wall-street strategists predict that the Bitcoin
will increase to levels between a conservative $50,000/Coin to a high of $1,000,000/Coin
by the end of 2020.”163 The advert does not mention that the price of Bitcoin fell from
$19,000 at its peak in December 2017 to under $7,000 in April 2018.164 The advert also
omits investment warnings that past performance is not a reliable indicator of future
results, that investments may fall as well as rise, and that the amount realised may be less
than the original sum invested.
118. David Geale, Director of Policy at the FCA, told the Committee how the FCA might
approach these advertisements were they to fall within the regulator perimeter:
If [crypto-assets] were to come into our regulatory remit, I imagine the
protection we applied would be similar to that we apply elsewhere. We
would look at things like the customers the firms are dealing with, who they
are targeting through their marketing, the standards of their marketing,
the standards of their disclosures through things like risk warnings, the
balance and sufficiency of those, and so on. […] For crowdfunding, for
example, we have taken steps to restrict the marketing to people who are
inexperienced investors at the outset, to try to stop them putting all their
life savings into it.165
119. Izabella Kaminska, Editor of the Financial Times Alphaville, told the Committee
that regulating the advertising of crypto-assets, crypto-exchange services, and related
products, would be an important step in furthering consumer protection:
At the moment, there is a wild west situation with the adverts. They are
deployed in a way that presents the impression that it is a one-sided market
that will go up and that anyone can make a lot of money very easily.
The advertising is prolific as well. It is not in any way catered towards a
sophisticated clientele. You see it on the tube. Younger people are being
exposed; older people are being exposed. Everybody is exposed at the
moment, so that is certainly one area that the Committee should look to.
120. David Gerard, author of Attack of the 50 Foot Blockchain, shared this view and argued
that “it would be appropriate to put in place strong consumer protection against misselling crypto-asset enterprises as investments to retail-level investors.”167
121. As well as considering the absence of regulation around crypto-assets for consumers
prior to their purchase, the Committee has also considered the implications of the lack of
regulation on consumer detriment once the assets themselves have been bought, and how
consumers can pursue redress and compensation.
122. This chapter has raised a number of ways in which consumers may experience
economic detriment and not be entitled to redress or compensation:
• Being mis-sold a crypto-asset that subsequently loses much or all of its initial
investment given the price volatility;
• Having your crypto-assets stolen through a hack on a crypto-asset exchange;
• Losing access to your crypto-assets when you forget the password to your
account with exchanges or crypto-asset platforms; and
• Investing in an ICO that is later found to have been a fraudulent or mis-sold
investment opportunity.
123. Mr Geale emphasised that the usual consumer redress and compensation, that
consumers have come to expect from FCA regulated financial services would not apply to
unregulated financial activities and products such as crypto-assets:
We have to separate the regulated space from the unregulated space. In the
regulated space, if it is a regulated firm that has done something wrong,
[the consumer] has a right to complain. They complain to the firm. Our
rules require the firm to deal with that in a particular way. If they remain
unsatisfied, they can go to the FOS [Financial Ombudsman Service].
If the firm has failed and has left a loss on the consumer that is not a trading
loss—for example, if the firm has misappropriated client money—they may
have a call on the Financial Services Compensation Scheme.
In terms of people in the unregulated space, they do not have access to
the ombudsman service and they do not have access to the compensation
scheme. […] Unless there is some kind of fraud involved or something,
their options are very limited.168
124. David Raw, Deputy Director of Banking and Credit at HM Treasury, noted that HM
Treasury may consider changing the regulatory perimeter to ensure consumers do have
access to mechanisms for redress and compensation:
If we discover that there are huge risks to consumers outside the regulatory
perimeter where people do not have recourse to the FOS or the FSCS, the
answer may well be that the Treasury legislates or takes action to change
where the regulatory perimeter is
125. The FCA’s consumer warnings are a feeble corrective to advertisements—on social
media, billboards, trains and taxis—that only emphasise the upside opportunities
of crypto-asset investing. The advertisements for crypto-asset investing are clearly
misleading to consumers and as crypto-asset activities fall outside the FCA’s regulatory
perimeter, the FCA is restricted in actions it can take. The FCA needs more power to
control how crypto-exchanges and ICO issuers market their services, by bringing the
activities they perform into the regulatory perimeter. Such a step would also provide
investors with wider protections against mistreatment, including loss of deposits
through fraud and hacking, or losing access to funds due to the loss of password