What is Wash Trading In Crypto?

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  • December 18, 2020
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How not to kill the goose that lays the golden eggs

Most cryptocurrency exchanges today are competing for ranking based on trading volumes. The higher the ranking, the more attractive they look to investors, traders, and users. With over 300 to 800 cryptocurrency exchanges operating, they sure would be jockeying for positions to gain a considerable chunk off the cryptocurrency market. Not only that, exchanges thrive on trading fees to keep them going, meaning, revenues depended on trades. So much so that they see no evil, hear no evil, and speak no evil when it comes to wash trading.

Fake Speak Volumes

A disturbing report coming from Bitwise Asset Management in 2019 presented to the US Securities and Exchange Commission declared that 95% of global trading volume reported by cryptocurrency exchanges were fake. They have been bloating their figures all along with false trades occurring on a daily basis. Trading volumes can reflect asset liquidity and market activity that are figures of enticement, but not in the world of cryptocurrencies. Market depth can be falsely perceived that can harm users and hurt the market. It is a dangerous precedent for a nascent industry working hard to gain the trust and confidence of a whole wide world for mass adoption.

Wash trading

is a kind of market manipulation wherein a trader, usually a big-time trader, issues a sell order and then would also place a buy order on that sell order. This self trade-off is called a wash trading since the sell and the buy ‘washes’ each other. It can also be that traders and brokers conspire to issue fake trades. Exchanges are also accused of this malpractice by trading on their own platforms. It can be deemed rampant among small, new, and unknown exchanges with low trading volumes which resort to wash trading to gain significant leverage on their trading volumes, and ranks, as well.

The unregulated crypto space is a virtual playground for wash trading, but not in the United States. Since the enactment of the Commodities Exchange Law in 1936, it is a criminal offense to create false signals of interest insecurities, attracting investors for FOMO, or fear of missing out.

Detecting wash trades can be an easy task as it usually happens on the bid-ask spread but does not register on the order book. Whereas on a normal trading day, a resting or limit order once lifted can be seen by other players, or remainders rest in the book if not fully filled. But with the age of computers and high-speed Internet connections using trading bots and algorithmic trading apps that can process thousands of trades per second, it has become increasingly difficult to track wash trading.

A Fake In Need of Real Help

Actually, there are calls to regulate the whole crypto space in general to curb wash trading in particular. Transparency can be the order of the day. If only exchanges can offer proof of reserves, wash trading would stop. The only problem is that there is no demand for exchanges to reveal their proof of reserves. So, they don’t bother to.

Another idea is the avoidance of trading games which would initially encourage the trading of a specified token. but when opportunists enter they would usually wash trades to win the bounty which they deemed higher than trading fees. After the game, the price would drop leaving the market in disarray. It will only serve the exchanges who will absorb the bounty through trading fees.

Exchanges can implement a solution wherein orders cannot be matched when it is coming from the same account. Traders may be in a quandary especially when they are trading on multiple models but a matching app can detect and avoid matching orders from the same source.

On a final note,

rating entities can produce a hybrid metric to evaluate the quality of an exchange not based solely on volume. They may also include in their technical trust rating judgment algorithms bid-ask spread, order book depth, API quality, web traffic estimations, and the quality of security protocols.

But all in all, a regulation that supports all these and other matters that seek to end dishonesty in trading should start to be tackled by the concerned.

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