Thread by @smdiehl

With everything happening this week, seems quite timely to talk about the shady underworld of cryptocurrency exchanges.

Because if you thought Robinhood seemed sketchy and corrupt, boy do I have a story for you. (1/) 🧵

Last week I talked about #Bitcoin's connection to organized crime in the form of the multi-billion dollar ransomware industry. (2/)

https://twitter.com/smdiehl/status/1353369991022784515

The business model of cryptocurrency exchanges is simple:

You have real money, the exchange has digital poker chips. They take your real money in exchange for letting you gamble on rigged games and they pinky promise they'll let you redeem chips. Except when they don't. (3/)

Normally this kind of operation would put you under the jurisdiction of CFTC or ESMA.

But in the crypto world you pick the shadiest jurisdiction from FATF greylist and just set up shop there. One where regulatory issues can be resolved with bribes and a briefcase of cash. (4/)

In order to take your customers money, you need to hook into the international banking system. So you set up an elaborate network of shell companies and correspondent banking relations layered out from the parent back to jurisdictions like Estonia, Liechtenstein and Malta. (5/)

This corporate structure is optimal for this line of business because you can suck in money internationally, pay no taxes, are accountable to no one, and the kicker is none of your customers have any legal recourse to do anything when you screw them over. (6/)

As an unregulated exchange with a blank check and no oversight, you do exactly what exchanges did back in 1929: paint the tape, front-run, manipulate prices, halt trading arbitrarily, pump-and-dump, wash trade, trade against your own clients and all manor of skullduggery. (7/)

Cryptocurrency markets are so plagued with market manipulation and pump-and-dump schemes it's hard to even call them markets.

Exchanges act like a wild west casino with loaded dice, manipulating their own order system and the market for its own direct financial gain. (8/)

A study by Dhawan and Putniņš found:

> There is at least one pump on 133 days out of the 175 days in our sample, indicating that there is almost one pump per day on average. Such a high rate of manipulation is unprecedented in financial markets

papers.ssrn.com/sol3/papers.cf… (9/)

Pump and dump schemes are simply a form of wealth transfer from less sophisticated participants to market manipulators. They serve no economic purpose other than to enrich colluding insiders at the expense of their victims (i.e. exchange customers). (10/)

The vast majority of cryptocurrencies being traded on exchanges are unregistered securities under US law. They are sold by insiders to the public with the expectation of generating a return based on the efforts of others. (11/)

Trading cryptocurrency requires investors to manage platform risk, counterparty risk, market level risk and asset level risk simultaneously.

On top of this using these unregulated exchanges has no legal protection or financial Ombudsman to protect consumers. (12/)

Exchanges are deliberately opaque to the European legal system, we don't even even known how many trades are even real. Exchanges regularly engage in wash trading, a practice where they trade with *themselves* to create an illusion of greater liquidity and manipulate price. (13/)

Some studies have estimated that nearly 95% of all reported trading in bitcoin is artificially created by unregulated exchanges through wash trading. (14/)
wsj.com/articles/most-…

Despite all this awfulness, the good news is that there is some slow progress by law enforcement. In the last few months not a week has gone by in which a major cryptocurrency exchange hasn't been indicted for financial crimes. (15/)

In September 2020 the US Justice department issued a civil forfeiture complaint against 280 cryptocurrency accounts linked to 11 exchanges in Korean region. These accounts were tied to laundering efforts by the government of North Korea in an effort to evade UN sanctions. (16/)

BitMEX exchange was recently indicted for financial crimes, its founders fled the charges and remain fugitives at large. In this insane world, while the founders are being hunted by the law, they continue to process $6 billion in daily transactions. (17/)
justice.gov/usao-sdny/pr/f…

The bulk of global cryptocurrency trading volume is passing through exchanges that form the backbone a dodgy shadow banking system. What is unclear to anyone is what the USD/EUR inflows and outflows of this system really are and how many customers are getting screwed by it. (18/)

The #Bitcoin get rich quick scheme requires two things. An influx of 74 terrawatts of energy to keep the pyramid standing and a growing pool of fools with unwavering faith that a system which is designed to siphon off wealth to insiders will somehow make them rich. (19/)

It's time to ask what the so-called "mission" of these cryptocurrency exchanges really is. There's a reason they don't want anyone talking about what goes on behind the order book, because it all looks pretty dodgy.

/fin