Back in June, the price of Ethereum crashed falling from $317 to 10 cents for a few milliseconds on Coinbase. It managed to recover quickly and the exchange offered to reimburse those traders who were impacted by it.
Now, the CFTC is interested in investigating the matter and particularly what role leverage had to play in the matter. They are also examining if there were any other factors that could have impacted on the price and caused the flash crash.
Leverage is where traders can enter trades with positions that are sometimes much larger than the amount they have available in their accounts. In the case of Coinbase, the leverage is 3:1. Hence, if you have one Bitcoin worth $4k then you can enter trades that are up to $12,000 in value.
This shows that the regulators in the USA are being proactive when it comes to digital currency regulation. For example, the Securities and Exchange Commission recently charged a man for promoting a fraudulent ICO. The SEC has also charged numerous Bitcoin Ponzi Schemes.
The CFTC on the other hand is in charge of the regulation of swaps and other derivative instruments. Given that Coinbase has issued these, they would fall under the scrutiny of the CFTC.
A Single Trade?
There were rumours that the cause of the flash crash was a single trade that was put through for $12.5m. This trade spooked the market and hence prompted selling by other investors. Many of the Coinbase traders had set up automatic stop orders once the price had fallen to a particular level.
These stop orders were therefore executed automatically which meant that quite a few traders faced large losses. Moreover, the stop orders created a chain reaction as more positions were liquidated. Coinbase also had to automatically liquidate traders with margin positions which could have further exacerbated the problem.
It appeared as if the sell order came from one of the first Ethereum blocks from 2014. This means that the buyer must have taken part in the Ethereum ICO where ETH was sold at 30 cents.
Although at this stage it looks as if the investigation is only in an exploratory stage as the CFTC sent a list of questions to Coinbase around the topic of margin trading. Coinbase has since suspended margin trading as a result of this crash. In a statement they said
As a regulated financial institution, Coinbase complies with regulations and fully cooperates with regulators. After the GDAX market event in June 2017, we proactively reached out to a number of regulators, including the CFTC. We also decided to credit all customers who were impacted by this event. We are unaware of a formal investigation.
In the end it seems as if the only party that was harmed by the crash is Coinbase as they have made whole on losses. It does, however, illustrate the risks of margin trading on cryptocurrencies with current market conditions.
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