Coinbase gets $6.5 million penalty from CFTC over in-house trading issues

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Coinbase (NASDAQ: COIN) has been hit with a US$6.5 million penalty from the U.S. Commodity Futures Trading Commission (CFTC). The charges, which the CFTC filed and settled on the same day, were for “reckless false, misleading or inaccurate reporting” as well as wash trading on its GDAX digital asset platform.

GDAX launched in 2015, and was rebranded as Coinbase Pro in 2018. GDAX/Coinbase Pro is aimed at more “professional” level traders, separate from Coinbase’s spot exchange and wallet apps for everyday digital asset traders.

The CFTC’s civil penalties on Coinbase apply to actions that took place between January 2015 and September 2018. A registration document Coinbase filed in February 2021 with the U.S. Securities and Exchange Commission (SEC) referred to a 2017 CFTC investigation into “topics including a 2017 Ethereum market event, trades made in 2017 by one of our then-current employees, the listing of Bitcoin Cash on our platform, and the design and operation of certain algorithmic functions related to liquidity management on our platform.”

A CFTC statement said Coinbase deployed two automated trading programs known as “Hedger” and “Replicator” that sometimes matched each other’s trades. Though the programs had separate purposes were not specifically designed to trade with each other, they inevitably did so—meaning Coinbase effectively traded with itself.

In addition, a former Coinbase employee had intentionally “used a manipulative or deceptive device” in August-September 2018 that wash-traded the BTC/LTC (Litecoin) pair. Coinbase was “vicariously liable” for its employee’s conduct as a principle, the CFTC said.

Coinbase allowed their employee to pump his own shitcoin using their liquidity and infrastructure, before cashing out.
I’m sure Charlie Lee was the only occurrence of such wrongdoing – that’s why their delayed their IPO by 2 weeks. https://t.co/An3FswRCEu

— Trolly McTrollface 🇱🇹🇺🇦 (@Tr0llyTr0llFace) March 20, 2021

The CFTC’s latest action signals that regulators in important jurisdictions have for some time been scrutinizing the behavior of companies in the digital asset industry, and are prepared to take action where necessary to protect investors.

Coinbase, BCH and BSV

In 2017, Coinbase received several customer complaints when it initially decided not to list BCH on its trading platforms in the wake of the BTC/BCH hard fork split in August that year. It eventually relented and listed BCH in December 2017, but suspended trading just hours later after the BCH price rose just prior to its announcement and then spiked dramatically as soon as trading began. It’s unclear if today’s CFTC’s penalties apply to this incident.

Dr. Craig Wright has also previously hinted that Coinbase may face legal issues over its listing of XRP. XRP’s creator company, Ripple, faces its own problems over accusations that the asset counted as an unlisted security.

Coinbase has so far resisted calls to list Bitcoin SV (BSV) on its platform, even during times when BSV was one of the top 10 digital assets by market cap. Following the November 2018 hard fork that split BCH and BSV, the company said it would split the coins and allow users to withdraw BSV units, but would not support buy/sell functions.

Wash trading and data reporting issues

“Wash trading,” which CFTC rules prohibit, is when a platform creates buy and sell transactions between its own accounts. Digital asset platforms have for many years been accused of this practice to either create the impression of higher activity or liquidity, or to manipulate prices. Wash trading is forbidden since it may affect the actions of “real” traders on the platform, but doesn’t carry any market risk itself or alter the company’s own position.

The CFTC’s statement doesn’t suggest Coinbase (the company) intended to deliberately manipulate markets with its algorithms, but that data containing their trades was still sent to market reporting firms including CoinMarketCap via Coinbase’s API. This meant that retail traders may still have used this information to make their own decisions.

The penalty is civil and the settlement amount is unlikely to make a huge dent in Coinbase’s profits. The company is not accused of performing any criminal actions, and the CFTC’s “wash trading” charge stemmed from the actions of a single and now former Coinbase employee.

Nonetheless, the CFTC’s Acting Director of Enforcement Vincent McGonagle added that “reporting false, misleading, or inaccurate transaction information undermines the integrity of digital asset pricing. This enforcement action sends the message that the Commission will act to safeguard the integrity and transparency of such information.”

Coinbase had also disclosed the CFTC’s investigation that led to today’s action on page 154 of its S-1 registration form with the SEC, at the end of February 2021:

“Many of the crypto assets in which we facilitate trading are subject to regulatory authority by the Commodity Futures Trading Commission, or CFTC. Any fraudulent or manipulative activity in a crypto asset occurring on our platform could subject us to increased regulatory scrutiny, regulatory enforcement, and litigation.”

Whether the financial penalty has an impact or not, Coinbase will likely be more careful in its future actions, knowing the SEC and CFTC will be watching.

Follow CoinGeek’s Crypto Crime Cartel series, which delves into the stream of groups-from BitMEX to Binance, Bitcoin.com, Blockstream, ShapeShift, Coinbase, Ripple and Ethereum—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.