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Monitoring Market Abuse in Crypto – What Lessons Can We Learn from Current Surveillance Best Practices?

BusinessCryptoMonitoring Market Abuse in Crypto – What Lessons Can We Learn from Current Surveillance Best Practices?
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TeaOver the past 12 months, high-profile issues with established crypto players have focused attention on the consequences of a lack of regulatory clarity. While trading in digital assets is not new, a clear regulatory framework is yet to be put in place.

As several regions work to determine how they will regulate crypto activity, the European Union (EU) is moving forward with its Markets in Crypto Assets (MICA) regulation.

Tony Seo, Head of Regulatory Strategy and Innovation for Nasdaq’s Anti-Financial Crimes business, was recently invited by the European Securities and Markets Authority (ESMA) to host a training session for over 500 attendees from National Regulatory Authorities (NRAs) Here are the key areas of focus for surveillance practitioners when it comes to MiCA. ,

We sit down with Sio to highlight some of the training’s key takeaways:

What exactly is MICA? What do surveillance practitioners need to know about it?

MiCA is one part of a wider digital finance package being rolled out across the EU with a possible effective date in 2024. Outside of Europe, the MiCA could help set global standards for the regulation of crypto-assets.

Any services and activities related to crypto-assets, including custody and exchange services, are subject to the MICA. Crypto-asset issuers that meet the criteria will be permitted to offer crypto-assets to the public or accept them for trading anywhere in the European Union. This approach should lead to a harmonized system across the EU.

Why is crypto surveillance different from traditional surveillance? What are some of the challenges unique to this landscape?

The major differences are the types of distributed ledger technology (DLT), the innovative new products being developed, and the actors participating in the ecosystem. However, if you look at the bulk of the activity, over 90% occurs on centralized exchanges that are off-chain, via an orderbook style approach. This activity is susceptible to many of the same risks that need to be controlled in traditional markets.

When looking at the ecosystem as a whole, many of the manipulative behaviors that occur in the crypto ecosystem are similar to those that occur in traditional markets. For example, wash trading is a well documented problem. In 2019, most volume wash trading was estimated to occur on tier two crypto venues, and people do this for exactly the same reason as in traditional markets, it attracts further volume.

There are also major differences in the nature of the markets themselves. Crypto markets are 24/7, have a history of being extremely volatile and include more novel forms such as perpetual futures. This means monitoring analysts are working with massive data sets across multiple markets and regions.

Given these challenges, what should surveillance practitioners know to prepare for impending regulation?

MiCA is aligned with the existing Market Abuse Regulation (MAR) of the EU, which applies to securities and derivatives. It is also in line with the EU Transfer of Funds Regulation and Financial Action Task Force (FATF) recommendations. This will make it more difficult for crypto-assets to be used for criminal purposes such as money laundering, terrorist financing and fraud.

There are five key articles of relevance to surveillance practitioners:

  • Article 76: Scope of rules on market abuse.
  • Article 77: Disclosure of insider information.
  • Article 78: Prohibition of insider trading.
  • Article 79: Prohibition of unlawful disclosure of inside information.
  • Article 80: Prohibition of market manipulation.

The onus is on CASP and other participants that facilitate trading in crypto-assets in the EU to implement rigorous monitoring programs. To detect market abuse, a CASP must be able to determine a baseline for normal behavior in a particular market down to the order book level and pick out unusual events or patterns.

They also need to follow ongoing developments in behavior over time. It is essential to monitor the full depth of the book as this is where manipulative behavior often occurs. It’s also important to build a process around the unstructured data contained in news releases and social media posts.

What are the key lessons we can learn from existing monitoring best practices?

One of the big lessons we as an industry have learned from events like flash crashes in the past is that markets and asset classes are inter-correlated. Different asset classes such as equity, derivatives and fixed income should not be viewed in isolation. As we build our monitoring programs for crypto-assets, we must take care that we do not create new isolated silos.

To learn more about how to best prepare for MiCA and other impending crypto regulation, read our whitepaper, Clearing the Way for Crypto-Asset Regulation: Explaining the EU’s MiCA Here



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