A company called Bitconnect, which is different than Bitcoin, has recently been made the subject of a class-action lawsuit alleging that it was a Ponzi scheme. The investors say that they collectively lost over $771,000 in their investment in the company and other damages. Bitconnect purportedly had a market capitalization of $2.6 million on January 6, 2018, but was of this writing about three weeks later, it is down to $128 million.

Next, according to another story, Tokyo-based Coincheck, Inc., reportedly lost somewhere around a half billion dollars’ worth of its customer’s blockchain tokens to hackers.

But as big as these numbers are, they pale in comparison to the research paper entitled “Price Manipulation In The Bitcoin Ecosystem” as published in the Journal of Monetary Economics that one person was able to manipulate the price of Bitcoin in 2013 from $150 to $1,000.

So, in a single week, we are presented with reports of significant fraud, theft, and price manipulation in the cryptocurrency markets. This is hardly investment Utopia, and sadly it seems that most of the folks who are having their shirts stolen in cryptocurrency are those who can least afford to lose it. In fact, there is increasing evidence that many of the Bitcoin and other cryptocurrency investors are not just gambling with money they can’t afford to lose, but they are gambling with money they don’t even have — by purchasing cryptocurrencies by taking advances on their credit cards.

All of this has made cryptocurrencies horrendously volatile — their trading charts look the waves of a Bering Sea storm (with the exception of Bitconnect and a few others which looks like that cliff which Wiley E. Coyote always falls from).

These bad things happen with governmental currencies too, but in a much, much lesser degree because those currencies are subject to government regulation and oversight. Take the dollar, for example. The dollar is just a little piece of paper, but it is subject to oversight by the U.S. Treasury, the Federal Reserve, among others. Behind the U.S. Treasury and the Federal Reserve are the U.S. Department of Justice and other law enforcement apparatus, such as the IRS Criminal Investigations branch. A private individual or group which attempts to significantly manipulate the U.S. dollar would find the full weight of the U.S. government coming after them and fast.

The U.S. is hardly unique in this regard. All governments, through their Finance Secretaries or Central Banks or whatever, carefully regulate their currencies. It is this regulation that causes the currency to be treated with some degree or another of predictability, i.e., currencies move in relation to the markets and to each other, but these moves are typically at much more of a glacial pace — routine daily swings of 10% or 20% just don’t happen (yes, sometimes a currency will crater, such as Iraqi dinars, but not on a daily basis).

Private currencies, including cryptocurrencies, are not regulated and have very little if any, protection against price manipulation. The only self-policing that exists is the market itself, which is to say that investors in a cryptocurrency may quit buying at a given price if they suspect that price manipulation is occurring, but maybe not. There simply is no agency that is both looking for signs of price manipulation and can come flying in with a Cease & Desist order that says, “Hey, you cut that out while you await the next-to-follow indictment.”

This brings us to the Government Regulation Paradox: Cryptocurrencies need government regulation to deter price manipulation and related wrongs, but the absence of such regulation is one of the biggest reasons that many investors buy into cryptocurrencies in the first place.

Otherwise stated, cryptocurrency investors desire the stability that comes with government regulation, but they don’t want the cryptocurrency to be regulated by the government.

The market alone will not fix this problem since, by the time the market figures out that significant price manipulation or fraud has occurred, it is a done deal. The horse is already out of that barn, and too bad so sad if you bought in at the high.

It may be that in the future governments will start issuing their own (regulated) cryptocurrencies, establish exchange rates, and to all the other things that it takes for a currency to become viable. The technology of currency has long been headed this way anyhow, with paper money about to go the way of pretty seashells and squirrel pelts.

But we’re not there yet. In the meantime, cryptocurrencies will continue to be highly volatile and subject to price manipulation. There is little doubt that we will see more Bitconnects where billions literally evaporate overnight.

Better take that into account before you borrow against your credit card to buy more cryptocurrencies.

 

 

 

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