The Case Against Crypto Market Conspiracy Theories

I used to be a professional trader, and although I eventually switched careers on account of too much stress and too little to show for it, the experience taught me several important lessons. The biggest one was that other than the basic notions of supply and demand, we often have no idea why markets do what they do.

That concept is anathema to all of the analysis, pundits and academics who are paid to tell us what happened, but it’s the truth, because it has to be.

You’ve probably heard the saying that “trading is a zero-sum game,” meaning that for every winner there has to be a loser. But that’s an understatement, because the brokers, exchanges and tax collectors always get paid. So in reality, on any timeline short of hodl, trading is a negative sum game. The average trader, like the average casino patron, will lose, sort of like the markets own law of money thermodynamics. The preferred enforcement mechanism? Confusion.

One of the most distinguishing characteristics of crypto markets is the prevalence and popularity of conspiracy theories. Every major move is explained by a shadowy group enforcing their will on everyone else. Why did Bitcoin go to $20k? Because Tether. Why did it crash to $6k? Because futures. Why does a small coin go up? Pump and dump. Why does a large coin go down? Whales!

Today, I’m going to make the case against these theories, starting with the simple argument that since markets are inherently inexplicable, no explanation, however benign or nefarious, should be given too much credibility.

That point is not as controversial as it sounds. Most veteran Wall Street traders would probably tell you the same thing, and one of the most popular investing books of the past 20 years is dedicated to the subject. My old boss, who used to write a column for a leading financial newspaper, was once told by reporters at his paper that even though they wrote daily headlines that explained the market, they really had no idea.

Some of the conspiracy theories out there are backed by statistical analysis. I’m even more skeptical of those, as crunching numbers formed the core of my old trading strategy, and years of doing so led me to one important conclusion: if you have a big enough dataset, and do enough research, you could find stats to prove almost anything.

That statement is not all that controversial, either. It was often conveyed down the trading desk via a fable about my mentor, one of the founding fathers of stat-driven trading. Supposedly, he once had a junior analyst so talented that he could make a statistically significant argument to go both long and short on any given day. So every morning, the analyst would show up with two envelopes of research behind his back, and ask the head trader whether he was feeling bullish or bearish. Upon hearing the answer, the analyst would respond with “then you want this envelope.”

Crypto traders have always been prone to believing in conspiracy theories, but the tendency has been kicked into overdrive of late thanks to the publication of academic papers claiming that Tether was used to manipulate Bitcoin up and futures used to bring it down.

Both reports are demonstrably wrong.

I traded futures for a living, so anytime I hear someone claim anything about them, I check the stats, as all trades on regulated futures products have to be reported. The one thing that’s abundantly clear about Bitcoin futures is that the actual level of usage has been small, bordering on insignificant.

The open interest, or total number of bets, in the past six months has never gone far past a few thousand contracts, or literally a fraction of the number of Bitcoins that get traded around the world in a single day. It’s unlikely that someone could manipulate a gigantic market using a tiny one.

Tellingly, the people who perpetuate this theory also perpetuate the false belief that until the launch of the CME and CBOE futures, there was no way to bet against, or short, Bitcoin. The paper above states:

“Before December 2017, there was no market for bitcoin derivatives. This meant that it was extremely difficult, if not impossible, to bet on the decline in bitcoin price.”

Except that the Bitmex Perpetual Swap Contract has been around for years and has always let you short. It’s literally the world’s most liquid Bitcoin market, and anyone could have used it to bet against Bitcoin on the way up, with massive leverage to boot.

Curve fitting is a popular sport among those prone to being fooled by randomness, and the best way to win is by leaving out examples that disprove your thesis. So while the FRBSF paper sites other markets, like housing, that topped out with the introduction of new derivatives, it conveniently leaves out the case of the Nasdaq 100 stock index.

Futures on that market were introduced in April of 1996, shortly before the dot com bubble that took the index from 600 to almost 5000, a seven hundred percent gain that blew up lots of people shorting the futures along the way. And if that’s not convincing enough, consider futures on the 10 year US Treasury Note, which were introduced in 1982, right at the start of one of the greatest bull markets in fixed-income history.

So if our academic friends had wanted to, they could have just as easily argued that the introduction of futures makes a market go up. Why didn’t they? Probably because they assumed — correctly — that you’d rather see the other envelope.

No crypto conspiracy theory has been more popular than the ones regarding Tether, and they all seem to have hit critical mass after the publication of this research paper, filled with scientific-sounding claims such as:

“Less than 1% of hours with such heavy Tether transactions are associated with 50% of the meteoric rise in Bitcoin and 64% of other top cryptocurrencies”

As we used to joke in my quant trading chat room, if it sounds like science, it’s probably science fiction. I’ll leave the line by line takedown of their analysis to others, because I want to focus on the big picture questions of How and Why.

Tether is tiny, at least relative to the overall market, hovering around 1% of the total crypto market cap. On top of that, only a fraction of the tokens are claimed to have been used to manipulate the market. To believe that the people who control Tether and Bitfinex used fake tokens to drive the crypto rally is to believe that just a few million dollars worth of something was enough to explode the value of the space by $500 billion. That’s an unlikely bang for the (tokenized) buck.

Even if such manipulation was possible, nobody has ever given me a satisfactory explanation as to why. Crypto exchanges are an increasingly valuable business, so the one thing we know for sure about the people who own Bitfinex and Tether is that they already own one valuable asset. I think it’s also safe to assume that what they don’t own is a majority of all the cryptocoins in existence. To believe that these people tried to manipulate the entire market higher is to believe that someone would jeopardize their own valuable asset (not to mention going to jail) to pull off a feat that would mostly benefit others — including you, Novo and the Winklevoss twins.

Would you risk a billion dollars to help the competition?

None of this is to say that there isn’t plenty in the crypto space that’s shady. Tether leaves a lot to be desired in terms of transparency, and there have been plenty of fraudulent ICOs and penny coin pump and dumps. But none of that explains why crypto exploded in 2017 and crashed in 2018.

So what does? Only that demand was more than supply, and then supply was more than demand. Everything else is conjecture. Uncertainty is a necessary condition of the market law of thermodynamics.

The one thing we do know is that crypto markets have always been insanely volatile, as any brand new asset class with no established valuation metrics would have to be. It’s not Tether and futures, it’s just FOMO and FUD; Buy the rumor, sell the news.

But that explanation doesn’t make for attention grabbing headlines, give skeptics a chance to mock crypto or give regulators an excuse to crack down, so it doesn’t get much airplay. What does are meaty conspiracy theories that presuppose that unlike the rest of us dolts, the would-be manipulators always have perfect knowledge of cause and effect. The Tether buyers somehow knew that their actions would make the market go up, and the futures sellers must have known that their shorting would definitely force the market down.

And therein lies the greatest argument against crypto conspiracy theories. If the perpetrators understand the markets that well, they don’t need to manipulate them. They’d make just as much money trading them.