Market manipulation is one of the main concerns the U.S. Securities and Exchange Commission (SEC) has cited in rejecting a number of bitcoin exchange-traded fund (ETF) applications. Solidus Labs, a technology firm, believes it has developed a technical surveillance solution to address this issue.
Solidus announced Wednesday it was rolling out a market surveillance tool to monitor crypto exchange transaction data and flag potential manipulation across different platforms, as part of an effort to address ongoing regulatory concerns about crypto markets.
“These are issues that have been largely resolved in traditional markets through market surveillance systems [that] were designed for traditional markets,” said Solidus Labs Chief Operating Officer Chen Arad.
Proponents say an ETF would make bitcoin accessible to a wider swath of retail investors by offering a regulated product that would be available on major investment platforms, such as Charles Schwab or TD Ameritrade.
However, a number of ETF applications have been rejected by the SEC, which has said the bitcoin market isn’t large enough to properly surveil. Chairman Jay Clayton, who will leave the role at the end of the year, has said in the past that a bitcoin ETF couldn’t be approved until the agency is confident the market was free from manipulation. One example of manipulation is wash trading, when a few accounts trade back and forth to make volume appear higher than it is using bots.
In 2019, the agency rejected Bitwise’s effort, saying there needed to be a surveillance-sharing agreement between an exchange and a market of “significant” size as one potential example of how to address this concern.
Solidus’ tool has four parts: data collection, data storage, data processing and reporting, Arad said.
The program collects data from a number of parties conducting transactions, mainly exchanges, acting as a sort of intermediary for the information. This ensures that exchanges aren’t required to share potentially proprietary trading data with each other, Arad said.
“The first part is being able to collect the data in a fully anonymized, obfuscated and encrypted way, and assembling it … in a multi-tenant database,” he said.
Solidus’ system then processes the information, comparing buy and sell data to look for potential wash trading or other forms of market manipulation.
Part of this processing includes comparing market information from accounts on one exchange to its “neighbors,” meaning accounts with similar attributes, said Solidus CEO Asaf Meir.
Neighbors are effectively a way of creating different types of broad profiles, which in turn act as a sort of average baseline for comparing account activity, if a user’s behavior diverges from the norm.
Solidus looks at an exchange’s reporting requirements, what alerts should be reported and which parties might be involved before sending these alerts to its clients.
“This type of data is extremely sensitive and confidential, and by the way that’s also how generally our product works right. Our product works off of private data that exchanges, broker dealers, regulators provide us with,” Meir said.
More broadly, this same technology can be used in different jurisdictions, potentially acting as a sort of global standard to help exchanges worldwide comply with the Financial Action Task Force travel rule, Arad noted.
Solidus is in discussions with a number of crypto exchanges and regulatory agencies to begin operating its surveillance tool in the U.S., though Arad and Meir declined to identify potential clients on the record, citing ongoing discussions.
Chris Land, general counsel at the Wyoming Division of Banking, said his agency is one of the regulators working with Solidus and evaluating its solution.
The company has already helped contribute to a section on market manipulation in an upcoming manual the division plans to publish, he said.
The tool is already in use with some other, non-U.S. clients, Arad said, adding that it had been developed specifically to address regulatory concerns.
“We were working with specific exchanges in a particular jurisdiction where they were required to apply for licensing. In that process we also started working with the regulator, and we generally developed the product with regulators,” he said.