It is no secret that many people think of cryptocurrency trading as the wild west. As a result crypto traders that suffer losses due to failures on crypto exchanges often do not know where to turn. However, a number of major exchanges (GDAX, Gemini, Kraken, Poloenix, and Bittrex) are based in the United States and thus subject to U.S. laws. They may therefore be liable for "flash crashes" that harm traders on their exchanges.
As all too many crypto-traders are aware, a flash crash is a rapid decline in the price of a cryptocurrency or token followed almost immediately by a rapid return to its earlier price. This rapid price decrease can trigger stop orders and force the liquidation of margin positions at prices far below the prevailing market price. Unfortunately, these flash crashes are often accompanied by exchange unavailability, leaving traders unable to effectively enter and exit positions and manage risk. The only logical explanation for these crashes is that they are the result of market manipulation, exchange failure, or both.
While almost all the major U.S. exchanges have experienced a flash crash at some point in the last year, this post will focus on the March 1, 2017 flash crash in GDAX's Ethereum/U.S. dollar market as the scale and speed of this crash illustrate the potential impact of such crashes. Prior to that crash the price of Ether had been trading consistently between $250 and $400 on the major U.S. exchanges for the preceding month.
In the minutes leading up to the flash crash, Ether was trading at approximately $310 on GDAX, with the price similarly between $290 and $310 per Ether on other major U.S. exchanges. Then GDAX's website ceased functioning for many users. Its web platform becoming entirely un-responsive leaving many unable to buy or sell Ether or manage their margin positions. Although GDAX's trading rules state that it may "[d]isable the ability to place new orders" when "technical reasons prevent or degrade traders' ability to place or cancel orders," it took no such action and left trading open.
In the moments that followed, the price of Ether plunged from around $300 to ten cents. This dramatic decrease was unique to GDAX as the price of Ether on other U.S. exchanges remained between $290 and $310. Within moments the price of Ether on GDAX recovered to approximately $300, but not before many users Ether holdings were forcibly liquidated at prices substantially below the prevailing market price. This apparently allowed certain traders to purchase Ether for as low as ten cents and recognize a 300,000% return in a matter of minutes.
GDAX stated that the cause of the flash crash was that a "multimillion dollar market sell was placed on the GDAX ETH-USD order book. This resulted in orders being filled from $317.81 to $224.48, translating into a book slippage of 29.4%. This slippage started a cascade of approximately 800 stop loss orders and margin funding liquidations, causing ETH to temporarily trade as low as $0.10." Although it would eventually refund lost Ether to traders (apparently recognizing its potential liability), GDAX nevertheless maintained that its investigations revealed no evidence of wrongdoing and that its software functioned properly throughout the flash crash.
However, this explanation defies common sense and basic assumptions people hold about functioning markets and exchanges. No rational actor would have sold Ether at prices as low as $224 when it could be sold for over $310 on other U.S. exchanges. Rather, a rational actor selling a very large volumes would spread those sales out both temporally and across exchanges in order to receive the highest possible price for their sale. The only logical reason to make a sale large enough to clear an exchange's order book would be to force liquidations and allow co-conspirators with very low limit order (e.g., those between $0.10 and $250) to scoop up liquidated Ether for pennies on the dollar.
Never before has an asset lost 99% of its value in moments only to recover that value in its entirety moments later. This type of market movement cannot be explained by the supply and demand principles that we trust to govern our markets.
The good news is that crypto-traders may be able to recover losses sustained as a result of a flash crash. If you have sustained substantial losses as the result of a flash crash it may be worth reaching out to an attorney to see what your options are. Depending on the circumstances surrounding your particular loss, you may be able to pursue claims for:
- Breach of contract;
- State unfair competition law; and
- Violation of the Commodities Exchange Act