The Coinbase Effect Shows The Power Of The US’s Most Important Cryptocurrency Platform
Bitcoin Cash surged more than 180% after Coinbase, the popular trading platform, announced it would allow for trading of the relatively new cryptocurrency.
On Tuesday, Justin Blau, a well-known DJ and amateur bitcoin trader, was fixed to his computer monitor, caught up in what he thought would be the latest cryptocurrency gold rush. It was 5:20 p.m. in his hometown of Las Vegas, and minutes earlier Coinbase, the most accessible place for Americans to buy and sell virtual money, had announced that it would allow trading of Bitcoin Cash, a derivative of the popular digital currency that has shot up more than 1,700% in the last year.
After forking, or splitting, from the original bitcoin protocol four months ago, Bitcoin Cash was trading in the mid-hundreds of dollars before speculation began that it would be imminently added to Coinbase’s trading platform. (Coinbase had previously announced that it would add support for the currency by the new year.) As the thinking on Twitter and Reddit forums went, the "Coinbase effect” would come into play, exposing Bitcoin Cash to the platform’s more than 10 million users, some of whom had joined to place bets on up-and-coming cryptocurrencies, and drive up the price.
In the two minutes after trading opened, the price of Bitcoin Cash, which had already risen dramatically on Tuesday, surged from around $3,500 to $8,500, causing total pandemonium. Traders, like Blau, sprinted to the platform thinking they could obtain massive returns in seconds, but soon found they were unable to unload most of their holdings after Coinbase froze activity "due to significant volatility."
“It was complete chaos,” said Blau, who said he could not tell if there were actually people buying the cryptocurrency at $8,500 or if it was just a glitch. Coinbase almost immediately halted trading, before beginning again the next day at around $4,000.
Tuesday’s fiasco, which has now raised accusations of fraud, insider trading, and other conspiracy theories, clearly shows Coinbase’s inherent power in shaping a market. In the nascent era of digital currencies, many believe fortunes can be won or lost depending on what Coinbase decides to do — or not do — leading traders to hang on the company’s every move.
While the company-owned exchange known as GDAX ranges between the world’s fifth- to seventh-largest cryptocurrency exchange by volume on any given day (it accounted for $1.5 billion of trading in a 24-hour period on Thursday, according to coinmarketcap.com), Coinbase’s true power is in its accessibility to normal people. Much like how Charles Schwab or TD Ameritrade function as brokerages for the retail stock trader, Coinbase, which has about $225 million in private equity funding, is likely the first place someone new to the bitcoin (or Ether or Litecoin) phenomenon would begin buying and selling. Earlier this month, following a swell in price and interest in bitcoin, the company’s iPhone app briefly held the title of the most downloaded software in Apple’s App Store.
“Coinbase is one of the only on and off ramps to crypto in the US,” says Dan Held, an early digital currency entrepreneur. Though there are other US-based exchanges like Gemini, owned by the Winklevoss twins, and Kraken, Coinbase, he said, “is the default and the easiest one to use” because of its simple user interface and dual functionality as both a trading platform and a place where you can store currency.
Coinbase declined to comment for this story or provide further details on what happened with the introduction of Bitcoin Cash beyond what it said in public blog posts.
If something goes on Coinbase, that will have a “massive effect” in how less sophisticated cryptocurrency investors perceive the coin, said Alyse Killeen, an early blockchain investor and a founding partner at StillMark. “These people can be more influenced by marketing messages and may confuse it with Bitcoin without understanding how the intrinsic value can be different,” she said. Some may buy a currency simply because it’s cheaper than a full bitcoin, valued at around $15,600 as of Thursday afternoon, without analyzing the risk or differences.
The Coinbase effect has been seen before, according to Ari Paul, an investor and cofounder of BlockTower Capital. In May, following Litecoin’s introduction to Coinbase, he documented a 30% increase, even after the currency had more than doubled its price in the months leading up to the move simply on speculation that it would be added to the platform. Similarly, Ethereum rose 14% on the day it begun trading on Coinbase in July 2016. (Ripple another cryptocurrency that is currently not traded on Coinbase, has also increased dramatically in price after rumors circulated that it would be added next.)
“Are these rallies rational? Yes,” Paul wrote in a May blog post. “There is a very heavy accessibility premium in cryptocurrency valuations. As a cryptocurrency becomes easier to purchase and easier to store, its valuation should rise…and it clearly does.”
Those rallies, however, were nothing compared to the one experienced by Bitcoin Cash, which rose more than 110% from Nov. 30 to the two hours before it started trading on Coinbase, and another 180% to $8,500 in the two frantic minutes of buying and selling, nearly three times the average price on other exchanges. Part of that was fueled by hints from Coinbase, which told users on Aug. 3 that the company planned to allows users to withdraw stored Bitcoin Cash by January 1, 2018, but would make “a determination at a later date about adding trading support.”
That’s why Tuesday’s decision came as such a shock to people like Blau, who rushed to get their Bitcoin Cash onto the Coinbase platform from their wallets -— specialized encrypted hardware or software for storing cryptocurrency — following the company’s afternoon announcement, but then found themselves prevented from selling following the trading halt. Others said they were blocked from selling in certain countries, and accused the company of artificially limiting the supply of Bitcoin Cash to jack up the price.
“The solution to this problem was for Coinbase to tell people in advance,” said Blau.
The meteoric rise in Bitcoin Cash’s price also led many crypto enthusiasts on Twitter and other social forums to allege insider trading among Coinbase’s employees or those who were able to learn of the the currency’s acceptance before the announcement. As a result, Coinbase CEO Brian Armstrong penned a blog post, noting that the company would be conducting in investigation to see if anyone violated policies on “trading on ‘material non-public information.’"
“If we find evidence of any employee or contractor violating our policies — directly or indirectly — I will not hesitate to terminate the employee immediately and take appropriate legal action,” he said.
It’s unclear what that means, however. There is no government body that regulates cryptocurrency in the US and a Coinbase spokesperson declined to detail what kind of agreements employees sign with regards to insider trading.
Tyson Cross, a lawyer who advises clients on tax and legal questions around bitcoin, noted that there may not be much a company like Coinbase can do if it finds that a worker has violated an internal policy. Coinbase could argue that an employee is in violation of a nondisclosure agreement or has harmed the company’s reputation by trading on non-public information, he said, but with people standing to make huge sums on large fluctuations in a currency’s price, “the risk to reward ratio is in your favor.”
“Aside from terminating employee or pursuing them on breach of contract, it sounds like he’s just blustering,” Cross said of Armstrong.
“It shows cryptocurrency is still in the Wild West," he added. "It exists outside a regulatory framework and there may be people benefiting on insider trading without repercussions.”