Policing Cryptocurrencies Has Become a Game of Whack-a-Mole for Regulators

Even if the commodity laws apply, proving manipulation can be difficult. The government must show that the trader intended to artificially affect the price. The Federal District Court in Manhattan once explained that “entering into a legitimate transaction knowing that it will distort the market is not manipulation — only intent, not knowledge, can transform a legitimate transaction into manipulation.”

One challenge to proving a defendant tried to inflate (or deflate) the price of cryptocurrencies is that, unlike stocks, they are not traded on centralized exchanges. Even simply gathering information on trades may be a challenge for prosecutors and regulators trying to prove manipulation. Moreover, virtual currencies can be traded from just about anywhere on the planet, so even if there is a pattern of suspicious orders the perpetrators may be beyond the reach of federal authorities.

Still, federal prosecutors possess two powerful weapons that are not available to the financial regulators at the S.E.C. and C.F.T.C.: the mail and wire fraud statutes. These laws cover deception and schemes to defraud involving valuable property, including intangibles like Bitcoin and Ether.

Although cryptocurrency trading firms often call themselves “exchanges,” they are not registered with the S.E.C. or the C.F.T.C, and their clients have none of the protections afforded investors who trade stocks and commodities. If the government is serious about monitoring the markets for cryptocurrencies, it will need to require the trading firms to comply with the rules for exchanges, which include extensive record-keeping provisions.

Perhaps in a nod to the inevitability of greater regulation, Coinbase, a leading cryptocurrency trading venue, is in talks with the S.E.C. about registering as a brokerage firm so that it can trade assets like Bitcoin and other tokens while complying with the securities laws. The company could create what is called an “alternative trading system” for buying and selling cryptocurrencies and tokens. Doing so would subject the firm to extensive capital and customer protection requirements along with oversight by the S.E.C. and the Financial Industry Regulatory Authority, or Finra. Coinbase clients could only trade assets that are properly registered with the S.E.C., another step toward treating cryptocurrencies as subject to the registration and disclosure requirements of the federal securities and commodity law.

Although becoming a broker would be costly, Coinbase could use that status as a marketing tool by telling potential customers that they will be much safer trading through its platform rather than unregulated firms that could see assets stolen or prices manipulated. Much like car companies tout their safety measures under rules they long fought, a broker can offer much greater client protection that customers may be willing to pay for.

As the value of cryptocurrencies swing wildly and those looking to abuse their investors proliferate, it may be up to Congress to finally designate an agency to be responsible for overseeing the markets. As I proposed in February, maybe it is time to create a Crypto-Cop to bring some order to the system and combat those looking for an opportunity to cheat and steal.

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