Security Shocks and Cryptocurrency Market Manipulations

• Main Author: Morin, Andrew
• Format: Dissertation
• Language: English
• Published: ProQuest Dissertations & Theses 01-01-2023
• Subjects: Computer science; Finance; Marketing
• ISBN: 9798384236641

As the cryptocurrency market has expanded, it has adopted a number of traditional financial market instruments. While supporters often cite the abolition of centralized control as the crowning achievement of blockchain technology, the vast majority of cryptocurrency trading occurs on highly centralized exchanges. These centralized cryptocurrency markets bear a striking resemblance to traditional financial markets, yet with only a fraction of the safety measures of their traditional counterparts. The abandonment of inherent blockchain security controls in this regulatory vacuum cultivates an environment ripe for abuse. This dissertation investigates the susceptibility of centralized cryptocurrency markets to security shocks and market manipulations resulting from this environment. We find that stable-coins, the reserve currency of the cryptocurrency ecosystem, are vulnerable to isolated security breach shock events. As centralized exchanges suffer breaches, they initiate a flight to safety response across the entire cryptocurrency ecosystem. However, as these markets mature, these isolated security breaches have an attenuating impact on these centralized stablecoin prices. This behavior aligns with the adaptive market hypothesis outlined by Andrew Lo, which relates this suppressed effect over time with a maturing market and more informed traders. Additionally, we find that interruption events at exchanges result in varying degrees of service disruption. Most interruptions are only partial outages, allowing privileged arbitrageurs unique opportunities to profit from price deviations between markets. Further, these interruptions could be criminally motivated as relatively inexpensive Distributed Denial of Service (DDoS) attacks can be used to create profitable arbitrage opportunities. Finally, using cointegration and causality tests, we identify a dual lead-lag relationship between cryptocurrencies and their perpetual futures contracts at centralized exchanges. The prices are highly efficient, and result in predictable responses following volatile price shocks. Using an event study methodology we find that large spot traders are disproportionately responsible for many such price shocks, and the futures price response provides profitable conditions for contract holders. Furthermore, the implementation of these derivative contracts fail to maintain efficient price tethering during periods of significant volatility. In the absence of regulations and standards protecting investors in traditional markets, cryptocurrency traders are often left little protection against these manipulations resulting in the potential for significant financial losses, and an absence of legal recourse for victims.