More exchanges implementing market surveillance tools

A Bitcoin ETF was first proposed in mid-2013 by investors Cameron and Tyler Winklevoss, who wanted to list their Winklevoss Bitcoin Trust exchange-traded fund (ETF) on the Nasdaq stock exchange. In the almost six years to follow, many other investment firms have also tried for SEC approval of a Bitcoin ETF. No one has been successful.

The Bitcoin ETF’s biggest hurdle

The SEC has repeatedly not granted proposed Bitcoin ETFs to be listed on US exchanges for a range of reasons. The most pertinent, however, is the lack of oversight and, thus, the potential for market manipulation on bitcoin exchanges.

As reported, when the SEC disproved the Winklevoss Bitcoin Trust for the second time in mid-2018, the regulator stated:

"[…] If BZX had demonstrated that bitcoin and bitcoin markets are inherently resistant to fraud and manipulation, comprehensive surveillance-sharing agreements with significant, regulated markets would not be required, as the function of such agreements is to detect and deter fraud and manipulation. But because the underlying commodities market for this proposed commodity-trust ETP is not demonstrably resistant to manipulation, BZX, as the ETP listing exchange, must enter into surveillance-sharing agreements with, or hold Intermarket Surveillance Group membership in common with, at least one significant, regulated market relating to bitcoin."

Similar concerns were echoed when the SEC rejected Bitcoin ETF proposals by ProShares, Direxion, and GraniteShares in August 2018.

Bitcoin ETF advocates may not want to hear this but the SEC has a point. Wash trading is a known technique which digital asset exchanges use to inflate their trading volumes as a lure to new users by seemingly having more liquidity than they really do..

The most recent report on this was published by the Blockchain Transparency Institute, which claims that over 80 percent of the CoinMarketCap top 25 BTC pairs volume is wash traded.

As a result of the rampant wash trading found on digital asset exchanges, Brave New Coin dropped several exchanges from its exchange-weighted pricing of major crypto asset pairs. Specifically, Brave New Coin dropped FCoin, CoinBene, CoinEx, and BigOne due to their engagement in "trade mining" from major pairs, including BTC/USDT, ETH/USDT, EOS/USDT, BCH/USDT as reported in July 2018.

Gemini hopes Nasdaq’s SMARTS market surveillance tech will help

In April 2018, the Winklevoss-owned regulated digital asset exchange Gemini announced in a press release that it will use Nasdaq’s SMARTS Market Surveillance technology to monitor trading activities on its platform and to surveil its auction process – used for the settlement price for the CBOE’s Bitcoin futures contracts.

"Since launch, Gemini has aggressively pursued comprehensive compliance and surveillance programs, which we believe betters our exchange and the cryptocurrency industry as a whole. Our deployment of Nasdaq’s SMARTS Market Surveillance will help ensure that Gemini is a rules-based marketplace for all market participants," said Gemini CEO Tyler Winklevoss at the time of the announcement.

The SMARTS Market Surveillance technology automates the detection, investigation, and analysis of potentially abusive or disorderly trading behavior on exchanges.

Specifically, "[Nasdaq’s] solution’s visualization tools simplify the monitoring process by distilling complex information into a single snapshot that provides clear guidance on where to focus an investigation. Additionally, the solution correlates real-time and historical data with detection patterns to ensure early detection of unusual trading patterns that could be potential breaches of exchange trading rules and practices," according to Nasdaq.

Fast forward to January 2019, when Laura Shin asked the Winklevoss twins on the Unchained Podcast about how they plan to make the SEC comfortable enough to approve a Bitcoin ETF in light of the fact that most bitcoin trading still occurs on unregulated overseas exchanges, they responded:

" […] The quick answer is answering their call and request for more market surveillance on the crypto marketplace and we’ve started to do that with the Virtual Commodity Association SRO and bringing Nasdaq’s SMARTS technology to our marketplace, and those are the steps in the right direction to getting regulators comfortable with eventually approving an ETF-like product."

How are other exchanges monitoring their trades?

In the grand scheme of things, Gemini is a small player. In October last year, though, exchange giant Binance announced a partnership with blockchain analysis and compliance firm Chainalysis to ensure that its trading platform complies with regulations.

Malta-based Binance has adopted Chainalysis’ KYT ("Know Your Transaction") compliance software, which monitors trading in real-time. "The software uses pattern recognition, proprietary algorithms and millions of open source references to identify and categorize thousands of cryptocurrency services to raise live alerts on transactions involved in suspicious activity." according to the Chainalysis press release.

In July 2018, Coinbase announced that was working on an in-house trade surveillance solution to better monitor its trading activities called the Coinbase Trade Surveillance Program, according to a report by Business Insider.

Moreover, according to a report by Forbes, aside from Gemini six further digital asset exchanges are using Nasdaq’s SMARTS Market Surveillance solution – including Japanese exchange SBI.

While there are limited details of how existing crypto exchange surveillance solutions function, it is clear that trade surveillance is on the rise. That is a natural progression for the cryptographic asset market as it matures into a mainstream asset class for both retail and institutional investors and should help us move closer to the much-awaited Bitcoin ETF.