Users Should Avoid Trading on Kraken at all Costs (Pt. 1)

Individuals may remember that there was an article being passed around the crypto space about a week or so ago that alleged that there was a ‘Bitcoin Bug’, which resulted in some crazy wicks to the north and south of a candle on the Kraken exchange Bitcoin market.

Below is a link to an article by CoinTelegraph detailing the mess:

Bug on Kraken Let Users Buy Bitcoin at Levels Below Market Price
_A bug on Kraken made it possible for traders to buy and sell Bitcoin at lower and higher levels than the market price._cointelegraph.com

Below are a couple of screenshots from the ordeal:

In the pictures above, we can see that the price of Bitcoin touched down to a price as low as $8,000, with a wick up to the north at a price as high as $12,000.

From the session low of $8,000, that’s a 50%+ jump in price. From $12,000 to the ‘equilibrium’ (market) price of approximately $10,300 — Bitcoin depreciated by approximately -14%.

What makes this price action remarkable is that this trade activity was not reflected on any other exchange at the time.

Thus, whatever was going on, on the exchange was due entirely to some phenomena occurring on the exchange alone.

Kraken Twitter Thread Explaining the ‘Bug’

After the wild and inexplicable price action in the Bitcoin markets, Kraken addressed the issue in a series of tweets (seen below):

https://twitter.com/krakenfx/status/1172948393196277761

Quick summary:

  • Kraken claims that the wild fluctuation in price in the Bitcoin markets was due to a ‘bug’ that arose from an ‘unreleased order type’, which resulted in the “order’s prices being matched against the wrong side of the book”
  • Apparently, this ‘bug’ led to some clients buying at the ‘tester’ price of $8,000, while others were able to sell at $12,000 without “clearing the intervening liquidity”
  • Apparently, only one trade executed at the ‘high’ ($12,000) and ‘low’ ($8,000) of the session [according to Kraken]

It is difficult to verify the claim that there was only one trade at the ‘high’ and ‘low’ of the session (which begs the question of how those trades were fulfilled; i.e., who was the counterparty to each trade?).

However, what is more troubling is the fact that this pattern of wild price fluctuations is nothing new when it comes to Kraken.

Kraken Has a Lengthy History of Fraudulent Market Activity and Questionable, Opaque Practices

This report will begin by taking a look at some of the more prominent instances of ‘flash crashes’ on the Kraken exchange over the past two years (there are countless instances apart from the ‘bug’ that was discussed above).

The point of bringing up these numerous ‘flash crash’ occurrences is to provide justification for our skepticism that the Bitcoin flash wick (going in both directions) on September 14th, 2019, was some sort of aberration on Kraken’s exchange.

In addition, this report will evaluate the following improprieties on Kraken’s exchange:

  1. The pending class action lawsuit by aggrieved customers
  2. The two lawsuits pending against Kraken for their failure to honor employee agreements
  3. Jesse Powell’s (CEO of Kraken) seeming indifference to the presence of trade/market manipulation on the Kraken exchange
  4. Kraken’s failure to institute any substantive controls in an attempt to reduce/minimize market manipulation
  5. Kraken’s failure to submit any information to the NYOAG (New York Office of Attorney General) when they were conducting an exchange survey in Q4 2018; this, among other factors, resulted in Kraken and two other exchanges being referred to the New York Financial Services for improprieties related to Kraken
  6. The massive amounts of money laundering / wash trading that take place on Kraken’s exchange
  7. That idiomatic nature of the USDT/USD markets on Kraken (notably, this is still the only viable market in all of crypto that allows for the swap of USDT to USD)
  8. Kraken allowing traders to use their markets free of KYC / AML for years (one of the reasons they were referred to New York Financial Services [NYFS] by the acting New York Attorney General at the time; circa Sept. 2018)
  9. Kraken’s obfuscated / rarely-mentioned relationship with Crypto Capital Co. (federally indicted payment processor)

Kraken’s Lengthy History of ‘Flash Crashes’

In normal circumstances, an exchange that has stood the test of time in the crypto sphere for as long as Kraken should be more than worthy of the benefit of the doubt when there is wild fluctuation in a market similar to what we observed toward the beginning of this piece on September 14th, 2019:

However, Kraken, in specific, warrants greater scrutiny and skepticism because this is far from the first time that we have seen an instance where it appears there has been a ‘flash crash’ or market manipulation of some sort impacting the price (in a way that diverges substantially from the rest of the major exchanges on the market; i.e., cannot be explained by ‘arbitrage’).

To emphasize this point, we’re going to cover some of the more prominent instances of ‘flash crashes’ on Kraken’s exchange by working backward from the September 14th, 2019 incident that we covered above.

Since there have been so many incidents on Kraken’s exchange, there is a solid chance that we will miss at least one incident. Thus, the numbers below merely represent the order of the numbered items in this specific article, and should not be considered to be a complete or holistic list of every ‘flash crash’ incident in Kraken exchange’s history.

Quick Review: What is a ‘Flash Crash’?

For those that do not know, a ‘flash crash’ (in this context) refers to an instance where the price of an asset (cryptocurrency) drops several percentage points in value, almost spontaneously, on a given exchange in a way that does not reflect the market’s valuation of said project at the time of the incident.

Example:

At the time of writing, Bitcoin is trading for approximately $10,200. If the price of Bitcoin were to drop significantly (i.e., to $6,000) for no explicable reason and this drop only occurred on Binance and no other markets (i.e., the price of Bitcoin remains at $10,200 on all other markets), then that would be considered a ‘flash crash’.

In terms of the spontaneity of the event, think of it as being similar to a ‘flash mob’ (referring to the trend that was popular like 2–3 years ago where crowds of people would break out in a synchronized, pre-planned dance in public at random), except instead of people dancing, the price is plummeting several dozen percentage points — causing liquidations, panic, and extraordinary, yet unnecessary losses.

Kraken ‘Flash Crash’ Event Log

Kraken Flash Crash #1 — June 2nd, 2019 [Bitcoin Market; BTC/CAD]

Long time crypto community member, Nick Cote, pointed out a ‘flash crash’ in the BTC/CAD (Canadian Dollars) where the price of BTC/USD crashed down from approximately $11,500 CAD to just $100 CAD ($75 USD).

https://twitter.com/mBTCPizpie/status/1135183402523475969

Below is the picture of the BTC/CAD markets from the tweet:

This fluctuation in price represents a depreciation of -99%.

Explanation:

Crypto publications and community members abound attempted to come up with rational explanations for the ‘flash crash’ on Kraken’s markets with theories ranging from a ‘rogue hacker’ to ‘exchange error’.

Among all of the possibilities, the theory of a ‘rogue hacker’ that compromised a large account(s) via API, first put forth by an individual on Twitter going by the pseudonym, ‘Beetcoin’, seems to be the most popular theory to date (pictured below):

https://twitter.com/Beetcoin/status/1135199936654565376

The theory appears to be somewhat corroborated by a pasted image of Kraken’s order book, showing a sell order for 1,155 bitcoins at the absurdly low price of $101 CAD/Bitcoin (-99% below market value at the time).

https://twitter.com/Beetcoin/status/1135250264607383553

At fair market value, these 1,155 bitcoins would have been worth $10 million USD. Instead, they were sold for approximately $87,000 USD ($115k CAD) instead.

It does seem miraculous that any individual would mistakenly sell $10 million USD worth of bitcoins for $101 CAD.

Some Other Aspects of the Situation That Are Questionable:

  1. The idea that there exists a trader that decided to store $10 million worth of Bitcoins on a 3rd-party exchange (Kraken or elsewhere), regardless of reputation. Given the propensity for crypto exchanges to be compromised/hacked/raided/exit scam/etc., 99%+ of individuals would more than likely seek their own personal means of storing cryptocurrency vs. an exchange. This is especially true when considering that exchanges do not have tiered security procedures for various exchanges given their hot wallet / cold wallet structure; so a user whose account holds a balance of $5 million+ would not be given any greater security precautions than a user whose balance is only $50 USD.
  2. As many commenters/observers mentioned, there isn’t much liquidity in the BTC/CAD markets to begin with, so the chances that a trader would initiate a trade where they’re attempting to sell 1,155+ bitcoins (more volume than what the entire market produces in a given day, total), is even more questionable.
  3. Even if the markets were extremely robust and liquid, the chances of any savvy trader (which one would imagine an individual with $10+ million worth of bitcoins would be) selling 1,100+ bitcoins at one price is extremely unlikely. The chances of slippage are astronomical at that price, resulting in an entirely preventable loss of tens of thousands of dollars.

Given the information presented by the Twitter user, ‘Beetcoin’, they are more than likely right in their supposition that some sort of foul play (i.e., a ‘hack’) took place.

As to how the account was compromised and whose fault it was, remains to be seen.

Potential Solutions:

  1. Kraken could follow the lead of other exchanges and simply implement ‘trade controls’ which prevent users from placing bids/sell orders that deviate more than X% (i.e., +/- 20%) from the asset’s market price at the time the order is placed.
  2. Kraken could restrict traders from placing ‘asks’ (sell orders) that would account for more than X% of the market’s total traded volume in a given 24-hour period. This would have the added impact of not only helping to prevent situations like what occurred in the BTC/CAD markets, it would also curb wash trading to a certain extent as well, which would further reduce volumes on certain markets, resulting in an even greater restriction of excessive trade volume from one or more affiliated parties (which Kraken allows despite its ‘rule book’ stating otherwise).
  3. Kraken could follow the path of the Dow Jones/NASDAQ/CBOE/CME/other institutional markets and simply halt trading on a given market if there is an unforeseen aberration in the price that deviates more than X% from the market price over a given period of time (i.e., volatility in excess of +/- 20% over a 10-minute time span). Most institutional markets in the United States have had this policy in place for well over 30+ years at this point (following the ’87 crash due to algo trading bots). These ‘trading controls’ are referred to as ‘circuit breaker’ rules.

What Are ‘Circuit Breaker’ Rules in Markets?:

Source: https://www.investopedia.com/terms/c/circuitbreaker.asp

[Sidenote: ‘Circuit Breakerswere literally invented as a means of preventing flash crashes on markets due to inexplicable reasons (i.e., panic selling/bots going haywire/black swan events/etc.) ]

Kraken Flash Crash #2 — April 25th, 2019 [Bitcoin Market; BTC/USD]

On April 25th, 2019, the price of Bitcoin wicked down to $1,000 on Kraken’s exchange.

https://thecryptoreport.com/flashcrash-btc-drops-and-rises-1000-on-kraken-in-5-minutes/

Kraken Flash Crash #3 — September 4th, 2018 [Ethereum Market; ETH/USD]

On September 4th, 2018, the price of Ethereum on Kraken’s exchange fell by over $40, spontaneously, in the ETH/USD markets.

This downward price move did not reflect trading activity on any other major exchanges at the time.

Below is a picture of the ‘flash crash’ on Kraken for Ethereum:

The drop represented an approximate (spontaneous) loss of -17% of Ethereum’s value.

While this may not seem like a lot, the time frame of the ‘flash crash’ as well as the volume of trading that occurred at this lower is worth noting.

Volume and Time of the Ethereum Flash Crash

According to ‘TrustNodes’, a longstanding cryptocurrency publication, during the flash crash, there were, “18,000 eth sold and bought within 1 minute at precisely 4:59AM London time.”

This volume would represent a total of $4M-$5M worth of trade volume in just one minute on Kraken. Whether this can be attributable to bots taking advantage of the insane arbitrage opportunity that such a ‘flash crash’ more than likely provided or a planned, executed exploitation of the situation, the volume is clearly indicative of some sort of measure(s) put in place beforehand (benevolent or nefarious) to take advantage of such an opportunity should it arise.

Potential Explanation:

As seen above, ‘TrustNodes’ entertains the possibility that this -17% wick may have been due to ‘fat fingers’ (a term used to humorously refer to the idea that a trader’s fingers are so ‘fat’ that they hit a different key on the keyboard than they intended target, leading to a simple clerical error; in essence, a simple human mistake [whether due to ‘fat fingers’ or otherwise]).

Once again, however, in this situation, without pinpointing additional mitigating evidence to corroborate this explanation (i.e., a user reporting verifiably reporting that they were responsible for said trade/public statement from Kraken exchange confirming such), there is no reason to accept that this strange depreciation in price was due to ‘fat fingers’ or any other user-sourced error.

Thus, it is just as possible that this error could have manifested itself via some sort of nefarious means.

Kraken Flash Crash #4 — March 19th, 2018 [Ethereum Market; ETH/USD]

Multiple users on various social media outlets reported a flash crash in the Ethereum (ETH/USD) market on Kraken exchange on March 19th, 2018.

Below is one of the posts from a Kraken exchange user that recapped the incident on Reddit:

https://www.reddit.com/r/ethtrader/comments/85icwe/flash_crash_on_kraken_this_morning_what_the_hell/

Below is the picture from the Reddit post shown above:

While the picture isn’t the clearest, what can be seen is an enormous wick for Ethereum on the 1-minute chart time resolution, showing the price crashing from approx. $530 down to as low as $435, representing a -18% delta in just one minute.

The volume in bars at the bottom of the chart displayed above show a noticeable spike in volume that appears to be exponentially greater than what the typical volume was for all periods before and after the period when the ‘flash crash’ occurred.

Explanation:

Absolutely none was put forth by the community, meaning that your guess as to what happened here is as good as anyone else’s.

Kraken Flash Crash #5 —May 7th, 2017 [Ethereum Markets; ETH/USD]

This is perhaps Kraken’s most infamous ‘flash crash’ to date as it resulted in a class action lawsuit by the Silver Miller law firm for tens of millions of dollars in damages.

Additionally, the multi-dimensional nature of the attack left many users questioning exactly what had happened.

The Incident:

On May 7th, 2017, there was a ‘flash crash’ in the ETH/USD market on Kraken’s exchange.

The price drop was captured by numerous members of the cryptocurrency community on social media and elsewhere.

Most notably, Tuur Demeester, longstanding member of the cryptocurrency community provided commentary on the ensuing price drop (as can be seen below):

https://twitter.com/TuurDemeester/status/861359108053663744

Below is the picture provided in the tweet in the above screenshot:

As one can see in the chart above, it appears that the price of Ethereum falls from a value of approximately $90-$95 all the way down to a session low of $29.75, representing a loss of approximately 70–75% as Demeester suggested in his tweet (cited above).

Kraken ‘Denial of Service Attack’ Hit Simultaneously

As if the aforementioned attack were not bad enough, users were apparently hit with some sort of ‘denial of service’ attack simultaneously, which rendered traders unable to adjust their positions in order to mitigate losses during the ‘flash crash’.

However, this ‘denial of service’ apparently did not affect all users because trade data shows that there were clearly algorithmic bots that were still able to access to the markets (either via API or other means) in order to place and fill orders (some of them maliciously).

Afterward, Kraken Asserts that the Denial of Service Attack on Users Was Entirely Unrelated

Over the next 24 hours, Kraken published several statements on multiple different social media platforms (as well as their own website), where they claimed that the Denial of Service attack on the exchange that impacted users during the ‘flash crash’ of the ETH/USD market on the exchange was entirely unrelated to said ‘flash crash’.

Below are screenshots of Kraken delivering this announcement to users in the r/ethtrader subreddit on the following day, May 8th, 2017 (posted by Jesse Powell, CEO of Kraken Exchange):

https://www.reddit.com/r/ethtrader/comments/69x2kl/kraken_announcement_may_7th_ddos_ethusd/

Summarizing the Reddit Announcement:

  1. Kraken claimed that the DDoS attack did not “cause or exacerbate liquidations”. While it could be possibly be argued that the DDoS attack did not, in itself, cause said liquidations, it is hard to imagine that traders being unable to log in to their accounts to meet margin calls and/or adjust positions/cover their positions or deploy an alternative trade strategy in order to mitigate the situation somehow did not exacerbate the losses due to liquidation. Claiming, “Once liquidations are triggered, they cannot be stopped”, does not address the obvious grievance that traders were not even granted the opportunity to adjust their trades in such a way where the liquidation event could have been potentially avoided altogether.
  2. Kraken (Jesse Powell, CEO) completely contradicts and defies its logic in the very next bullet point of the announcement by justifying their failure to halt trading during the ‘flash crash’, with the statement, “The consequences for traders would have been even worse. Crypto assets trade on many exchanges and shutting down an individual market simply means that participants there cannot react to the changes elsewhere.” Essentially what Kraken is saying in this quote is that preventing traders from accessing the exchange to react to the rapidly changing market conditions would have adversely impacted said traders. However, in the previous point, Kraken argued that the denial of service attack (which prevented traders from accessing the exchange) had no impact on how many individuals were liquidated and played no role in exacerbating the attack either.
  3. In response to the self-constructed demand, “Kraken should only liquidate at the ‘real’ price”, the post rebuts this point by stating that traders are encouraged to “use advanced order types such as stop-loss to set their own exits.” However, in an event such as the one that took place on Kraken’s ETH/USD market on May 7th, 2017, it is highly unlikely that a S/L trade would have been effective. Additionally, as noted before (and implicitly acknowledged by Kraken), many traders cited their inability to access the exchange as a key reason for why they were unable to utilize such advanced order types to provide assistance for their efforts to exit their positions without experiencing maximum loss.
  4. In response to the self-constructed statement, “Kraken should roll back trades”, the post asserts that ‘Kraken cannot roll back trades’, explaining that, “Kraken also took on losses as the result of accounts going negative through liquidations.” Thus, it appears that the statement ‘Kraken cannot roll back trades’ is inaccurate and that the reality of the situation is that Kraken refuses to roll back trades. ‘Cannot’ refers to some sort of technical/physical impossibility, which did not appear to be the case. Additionally, the explanation Kraken provided for why they could not ‘roll back’ trades actually serves as an apt justification for why Kraken should have rolled back trades. If Kraken, the exchange, also suffered losses as a result of the ‘flash crash’, then it stands to reason that rolling back said trades would also be in the benefit of Kraken. By refusing to do so, Kraken is essentially stating that they adamantly stand behind their losses (which makes zero sense).
  5. Under the same subsection [Kraken should roll back trades], the post makes the statement, “Unfortunately, for an exchange, market integrity is sacrosanct. Traders must be able to rely on legitimate trades being honored. Any losses today are the gains of the trader who took the risk to provide liquidity on the other side.” This statement is also problematic because a trader deciding to accept a margin long trade on Ethereum while ETH/USD is trading at more than 70% below the going market rate on all other exchanges during a time where the exchange in question that is offering said prices is clearly compromised is not taking a ‘risk’, and it should be obvious to all market participants that said trades are not ‘legitimate’, because the ‘flash crash’ is clearly not the result of legitimate price discovery, but rather market manipulation or some other nefarious activity/exploit in the exchange’s software itself. Thus, it comes across as hypocritical, at best, to assert that the “market integrity is sacrosanct”, while simultaneously upholding and legitimizing the activity of bad actors. Additionally, Kraken failed to state whether the flash crash resulted in a net loss or not. While it may be true that Kraken lost some amount of funds on the exchange as a result of these liquidations, the post noticeably failed to mention what profits, if any, Kraken gained as a result of the cascading liquidations, S/L’d positions, etc., from the flash crash. Kraken also failed to mention whether they were or do hold any positions on their own exchange, specifically on its leveraged markets.

User Response

As one can imagine, the general user response to the thread was a mix of anger, frustration, disbelief, and disappointment.

Some interesting responses included screenshots which appeared to show that some features were enabled for some users, while being disabled for others.

In particular, it appears that Kraken had limited how much it could lend to users on margin for the ETH/USD markets due to the limited availability of Ethereum for the exchange:

https://imgur.com/K8s4B3b

Conclusion

In follow up editions, we will look at some of the additional factors that make trading on Kraken an extremely risky, if not outright unwise choice for trader in the crypto sphere.