Crypto Wash Trading Explained In Simple Terms

Many in the cryptocurrency space rely on data from veteran crypto rankings sites, such as CoinMarketCap and Coingeko, when it comes to researching the liquidity a certain exchange has, and how much a certain digital asset is being traded. That information, however, is not always accurate due to the prevalence of wash trading in the crypto sector.

It is a sad fact, but wash trading has been a part of the cryptocurrency industry for years now, and only recently has there been a drive to reduce its stranglehold. According to a number of reports and researches, the majority of crypto trading volume has been and is still being faked, with some even claiming that 95% of the total were just the result of wash trading.

What Is Wash Trading?

Wash trading has been present on traditional markets for decades, and refers to the act of buying and selling a security with the express goal of feeding misleading information to the market. This was made illegal in the U.S. after the federal government passed the Commodity Exchange Act in 1936.

While not very popular on traditional markets anymore, wash trading has been used for years as a way for stock manipulators to attempt to pump an asset’s value, and then make money on shorting the same stock. On a smaller scale, wash trading has also been used as a way to claim tax deductions from the government, as investment losses are generally tax deductible. The IRS has limited this activity by prohibiting taxpayers from deducting losses on a sale, if the investor repurchases the same asset 30 days before or after the sale.

With regulations and laws making wash trading extremely hard to do on traditional markets, it found its way to the crypto sector, where it is used to artificially inflate the trading volume of exchanges and crypto assets.

Wash Trading In Cryptocurrency

With the ever-increasing popularity of cryptocurrencies, more and more exchanges, and new crypto firms, have started to emerge on the market, all trying to attract as many users as possible to their platforms. One way companies and exchanges try to lure users in is through high trading volume and liquidity. While there is nothing inherently wrong with that, firms often assign large scale traders to wash trade their assets.

These traders would often use one account to place a sell order, let’s say 100 ETH at $350 each, and then a buy order with a second account, for the same 100 ETH at $350 each. By doing this the trader does not suffer any losses aside from the exchange’s fees, but creates trading volume meant to attract more users to the particular cryptocurrency or exchange platform. This operation can be automated with bots, making this back-and-forth trade extremely quick, allowing companies to easily fake the interest in a particular asset.

Wash trading in the crypto sector was more severe than people thought, as shown by a 2018 study conducted by the Blockchain Transparency Institute (BTI), which claimed that around 80% of the crypto trading volume was fake. It also pointed to some exchanges, which apparently had 99% of their volume faked, allegedly making money from coin listings instead of trading fees.

Bitwise had also conducted a survey of its own, though the crypto firm claimed its findings showed that as much as 95% of the total trading volumes were faked. The Block, on the other hand, looked at 48 crypto exchanges and their volumes, and concluded that 86% of their total volume was fake. No mater which the correct number is, wash trading is a major issue for the crypto space, and its growth.

Solution

While the numbers shown above might be discouraging, the cryptocurrency community has already started to act. Back in 2019, BTI released a report claiming that the global wash trading in cryptocurrency markets has gone down by around 35% on the 40 largest crypto exchanges.

Many of the top crypto ranking websites have also been trying to tackle the problem of false trading volume reports from exchanges by implementing new ranking methods. According to BTI’s “2020 Market Data Integrity” report:

“Only 31% of the CoinMarketCap top 25 is being wash traded compared to over 90% just 1 year ago, a 3x improvement with their new rankings system.”

So what did CMC change in the way it views data? The website’s new model attempts to detect outliers by comparing web traffic data and the liquidity of a given exchange, which can help it detect whether there is “too much volume” for too few users.

It’s not only exchanges and ranking websites that have started to fight back. Earlier this year, the third largest crypto exchange in South Korea, Coinbit, was seized by local authorities, after its management team was accused of fraud, and artificially inflating the exchange’s volume and manipulating token prices.

Can We Get Rid Of Wash Trading Completely?

It might be impossible to completely stop wash trading from occurring in the crypto sector, considering that exchanges and new companies are doing it for the sake of attracting more users to their platforms. This, however, is not a reason not to try and reduce its impact as much as possible.

One way to reduce fake volume, is for countries to implement more rigorous regulatory frameworks in the sector, specifically targeting wash trading. With that said, even if wash trading was made illegal on a worldwide basis, bad actors will still find a way to use it for their benefit, which means that we, as a community, need to take things into our own hands. Exchanges need to try harder to eliminate such practices from their platforms, and take appropriate actions against bad actors.

Summary

While wash trading does bring short term benefits to a few businesses, when looking at the big picture, it can only hurt the crypto industry in the long run. Such a widespread practice can only create a negative impression of the crypto space, which will eventually impact all businesses.