Bitcoin Exchange Bitfinex Denies Allegations of Insider Trading

The word 'Bitfinex' in blue font. Below this is the text 'Invest in the future'. The two lines are separated by a green line. To the right is a graphic of a leaf.Bitfinex CSO Phil Potter came under a cloud this past Thursday, after an interview in which he seemed to be admitting to insider trading at Bitfinex. The interview was contained in a podcast that was posted on Vocaroo, an online voice recording service.

In the voice recording, Mr. Potter can be heard strenuously clarifying that he was a Bitcoin investor. He adds that he had not been involved in actual trading on his Bitfinex trading platform saying that such an action would be “highly inappropriate”.

Bitfinex has come out in defense for Mr. Potter. Josh Rossi VP for Business Development issued a statement posted on Reddit defending Mr. Potter’s trading at Bitfinex. In the statement, he explained that Phil Potter had been managing a fund that dealt in cryptocurrencies prior to his arrival at Bitfinex. He had ceased trading once he took up his role at Bitfinex.

He also explained that the management team at Bitfinex regularly monitored the accounts of company officials, an action that was designed to create “checks and balances” on each member of the team. In the statement, Josh Rossi added that all of Mr. Potter’s orders had been limit orders, a kind of order that among other things is designed to cut losses should the asset start experiencing a bear run.

Several comments on this statement indicated that the community was not convinced. For example, Reddit username Waldoraj asked about how they would go ensuring that employees at Bitfinex do not use anonymous wallets. Others felt that in the interests of transparency, it would be best if company officials would trade their Bitcoin assets on other exchanges so as to avoid conflicts of interest.

Conflicts of Interest – How They Arise

The conflict of interest would arise in a couple of ways regarding Bitfinex and other bitcoin exchanges. One of them has to do with what are called margin calls. A margin call occurs when the amount posted in a margin account falls below the minimum margin requirements for a particular asset class, in this case the asset being Bitcoin. In the above example, as a senior company official at Bitfinex, Mr. Potter would have access to information on Bitfinex clients. He knows their holdings, including any hidden orders. Such information gives him a competitive advantage over other traders.

To illustrate how the conflict of interest could arise, think back to the recent collapse in Bitcoin’s price against the US dollar. When the price begins to drop slightly, all a manipulative trader will do is initiate margin calls. Several margin calls would trigger a rush to sell bitcoins thus enabling him become a Bitcoin whale by purchasing as many bitcoins as possible for as low a price as he can.

Another conflict of interest would arise from stop loss orders. Normally, stop loss orders are used by traders to hedge against loss or position in a security. Stop loss orders work well because they take the emotions out of trading decisions, and they can be employed by an investor who has to attend to other matters or may be physically away for some extended time period.

A manipulative trader could easily use insider information to distort the price of an asset such as Bitcoin. Such a trader could begin to issue margin calls and stop loss orders thus enabling him to collect as many coins, in other words, build a long position. The goal is to buy as many coins as possible for the least possible price, which eventually turns him into a Bitcoin whale.

Bitcoin Whales

As Bitcoin’s current capitalization is still low, the effect of a whale on Bitcoin’s price can be markedly pronounced. As previously explained, a whale’s goal in the early stages would be to keep the prices low so as to enable them buy more bitcoins. With insider trading, this becomes easy to do, as all a whale would have to do is to trigger as many stop loss orders as possible in an effort to entice others investors dump their own bitcoins.

The effect of this is to avail more coins on the market for an even lower price, after which the whale would attempt to inject capital so as to increase the prices. The goal of such pumping is to inflate the value of the coins to as high a price as possible before letting the market correct itself by sending the bitcoins back to the value where they are meant to be.

In as much as Bitfinex has cleared the air on this, there is, however, a real need of ensuring transparency in crypto trading. This will become even more important as Bitcoin continues to mature as a viable digital asset.

Last modified: March 4, 2021 4:42 PM

John Weru Maina

John Weru is a Kenya-born writer who has been writing since his teenage years. He believes that digital currencies hold the key to unlocking the potential of e-commerce and m-commerce globally, and powering Africa's participation in international trade.