By now, it’s common knowledge that Sam Bankman-Fried (SBF) was secretly routing FTX customer funds to his trading firm, Alameda Research, and used it to trade against those same customers on FTX. Oh, the irony.
Unfortunately, FTX isn’t the only crypto exchange that trades against its own customers — and the practice has a long history.
In the 1990s and 2000s, binary options exchanges and forex exchanges regularly operated ‘B Book‘ exchanges — where forex brokers take the opposite of a customer’s bet and accept the market risk. As opposed to ‘A book’ forex brokers who actually fill customer orders on an independent exchange, B book brokers simply notate customer orders and settle trades internally.
Digital asset exchanges likely trade against their customers more often than they want to admit. Its prevalence is likely as pervasive as B book binary options and forex exchanges. In fact, the name of major crypto exchange Binance, currently embroiled in a mountain of regulatory woes, is a portmanteau of ‘binary options’ and ‘finance.’
“Crypto’s got a lot of those challenges — of platforms trading ahead of their customers,” Securities and Exchange Commission (SEC) chair Gary Gensler told Bloomberg in 2022. “In fact, they’re trading against their customers often because they’re market-marking against their customers.”
Indeed, when most customers lose money trading on leverage, there are financial incentives to trade against them. FTX was especially egregious insofar as it directly siphoned customer funds from the exchange to trade against them on its own exchange.
Most digital asset exchanges at least begin with separate funds and only later commingle customer funds with their trading firm. So, let’s take a closer look at crypto’s entanglements with betting against customers.
Alleged trading against customers at Mt. Gox
A former customer named Gregory Greene was a plaintiff in a proposed class-action lawsuit that began in 2014, alleging that Mt. Gox chief exec Mark Karpeles created a Gox Bot that could trade against customers using money collected from trading fees and “debt for Mt. Gox.”
The court rejected Greene’s motion for class-action status for the lawsuit and also denied Karpeles’ motion for summary judgment.
In 2019, a Japanese court dismissed most of the initial charges against Karpeles but convicted him of falsifying data due to activity related to the Gox Bot and Karpeles’ alteration of records to inflate Mt. Gox’s holdings.
In 2018, BitMEX chief Arthur Hayes admitted to for-profit trading using a market maker owned by the crypto exchange. BitMEX also offered up to 100X leverage. Its executives knew that most leveraged traders would be liquidated (lose money).
Rather than staying independent, BitMEX operated a second, for-profit trading firm that overtook liquidated BitMEX customers’ trades.
That admission by BitMEX executives came after months of investigations into BitMEX’s “market-making” activity. The Commodity Futures Trading Commission (CFTC) alleged that BitMEX violated the Commodity Exchange Act (CEA) by operating an unregistered facility that acted as a counter party for some of its own customers’ trades.
That matter ended with the CFTC announcing a settlement with the companies operating BitMEX in which they agreed to pay $100 million in fines.
CFTC says Binance traded against customers
On March 23 of this year, the CFTC filed a complaint alleging that Binance chief Changpeng Zhao (CZ) committed several violations of commodities trading regulations.
The alleged violations include “operating a facility for the trading or processing of swaps without being registered as a swap execution facility.” The CFTC also alleges evasions of provisions of the CEA.
CZ-controlled entities Sigma Chain and Merit Peak operated hundreds of accounts that took the other side of many Binance customers’ trades, according to the CFTC.
On October 15, 2021, the CFTC ordered Bitfinex to pay $1.5 million in fines to settle charges, including illegally acting as a counterparty for trades. The CFTC alleged that Bitfinex’s peer-to-peer lending program funded most margin trading, and Bitfinex frequently liquidated some customers’ positions.
Specifically, the CFTC claimed that, “Bitfinex force-liquidated certain customer positions and acted as the counterparty to certain transactions. In so doing, Bitfinex violated the terms of the 2016 order, which had directed Bitfinex to cease and desist from offering, entering into, executing, or confirming the execution of illegal, off-exchange financed retail commodity transactions, and from accepting orders and receiving funds in connection with retail commodity transactions.”
Trading against customers at Abra
On July 13, 2020, the CFTC ordered two companies operating the Abra exchange to pay $150,000 in fines for violations of the CEA. Abra operated a mobile app that allowed customers to create digital asset and foreign currency contracts and sometimes acted as a counterparty for contracts.
Specifically, by “acting as the counterparty” and “by entering into these contracts via their app, respondents violated Section 2(e) of the CEA, which makes it unlawful for any person, other than an eligible contract participant, to enter into a swap unless the swap is entered into on, or subject to the rules of, a board of trade designated as a contract market.”
“Additionally, in soliciting and accepting orders for these contracts, the respondents illegally operated as an unregistered futures commission merchant,” the CFTC said.