Researchers at the University of Texas at Austin found that at least half of bitcoin's astronomical returns last year may have been a result of manipulation.
What may be at the center is another digital token called tether.
Tether, whose price is equivalent to the dollar, was designed to make cryptocurrency trading more seamless, by converting cash into digital currency.
The company behind the token, also called Tether, claims that each tether "is always backed 1-to-1, by traditional currency held in our reserves." Tether is sold by the cryptocurrency exchange Bitfinex and is also used on other cryptocurrency marketplaces including Poloniex and Bittrex.
The researchers examined transactions where people bought bitcoin using tether. On many exchanges, purchases can be made using only cryptocurrencies, not dollars, which makes tether a useful trading tool.
They found that purchases were timed following downturns in the cryptocurrency market, leading to "sizable increases in bitcoin prices" according to the paper, which was reported on first by the New York Times.
The findings suggest that the issuers of tether were pumping out the token to purchase bitcoin, creating an artificial demand for the cryptocurrency, and driving up its price.
The timing and magnitude of the purchases can't be explained by organic investor demand, the researchers said, which suggests that tether may have been issued without being fully backed by dollars.
"Bitfinex seemed to be sending out tether to purchase bitcoin around these large price drops, and also doing so around round number thresholds," said John Griffin, a co-author of the study and a finance professor at the University of Texas, in an interview with The Washington Post.
Griffin found that the tether transactions coincided with bitcoin prices that were multiples of 500, indicating that manipulators may have been attempting to demonstrate a price floor, a benchmark of support, stabilizing the price of bitcoin. This may have encouraged other investors to jump in and buy.
"People tend to anchor onto salient price points," he explained. Those crucially timed bitcoin purchases could have acted like a psychological anchor, luring other people to pile on and invest in bitcoin, sending the price upward.
Emin Gün Sirer, an associate professor of computer science at Cornell University, said that tether-like instruments, when used legitimately, are crucial for efficient markets.
They provide benefits like quick transfers between exchanges without having to convert digital currency into dollars and back again. But people can also use a currency like tether to goad investors into trades they wouldn't otherwise make.
"This study provides substantial but circumstantial evidence that tether was used for the latter purpose, in addition to the former," he said.
"Note that it's circumstantial: The authors discovered various indicators that indicate that tether use isn't organic, but they can't conclusively rule out that the behavior they observed was due to, say, a well-funded entrant into the space, slowly buying coins in response to price dips."
Sirer said that an entity with subpoena power could bring much needed clarity by examining the records of various cryptocurrency exchanges.
In a statement Wednesday to The Washington Post, Bitfinex and Tether chief executive JL van der Velde said: "Bitfinex nor Tether is, or has ever, engaged in any sort of market or price manipulation. Tether issuances cannot be used to prop up the price of bitcoin or any other coin/token on Bitfinex."
Christian Catalini, a professor and founder of MIT's Cryptoeconomics Lab, said the paper "raises some valid concerns," adding that the cryptocurrency community has been talking about these issues for months, but without a healthy supply of empirical work to measure the presence and degree of manipulation.
"It is great to see academic work in this space given the relatively opaque and not always very liquid nature of these markets at the moment," he said.
This isn't the first time that Bitfinex, which describes itself as the "world's largest and most advanced cryptocurrency trading platform," has drawn scrutiny.
Earlier this year, Bloomberg reported that the exchange and Tether were subpoenaed by U.S. regulators in December, following reports and commentary that were critical of its financial practices and lack of transparency. Tether also said that hackers stole more than $30 million worth of its token.
The research appears to validate speculation that grew louder during bitcoin's peak last year, that tether was being used to pump up the price of the cryptocurrency, said Angela Walch, an associate professor at St. Mary's University School of Law and a research fellow at University College London's Center for Blockchain Technologies.
The paper also demonstrates the need for regulations and a pause on churning out new crypto-based financial products such as bitcoin exchange traded funds (ETFs) and futures, she said.
"The crypto economy has largely grown up outside the regulations of the financial system and the exchanges have been largely unregulated. This has been a shadow financial system," Walch said.
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