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(Kitco News) – Unregulated cryptocurrency exchanges, where the vast majority of cryptocurrency trading takes place, routinely engage in wash trading to boost profits and inflate volumes, according to a new study by researchers at the US National Bureau of Economic Research.
In the “Crypto Wash Trading” working paper, authors Lin William Cong, Xi Li, Ke Tang, and Yang Yang analyzed cryptocurrency transaction information in the TokenInsight database from 29 major exchanges, including Binance, Coinbase, and Huobi, as well as the lesser-known ones traded from 9 July to 3 November 2019 for wash trading trials.
The authors define wash trading as “investors simultaneously selling and buying the same financial assets to create an artificial activity in the market”, which distorts price, volume and volatility and affects investor confidence and participation in financial markets.
Exchanges were chosen based on their position on third-party websites, representativeness and API compatibility, and were sorted into Tier-1 (ranked in the top 700 in the Finance/Investments section of SimilarWeb.com) and Tier-2 ( all ranked outside the top 960. The authors focused on trading Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Ripple (XRP), the four most traded cryptocurrencies against US dollars at the time.
To detect wash trading patterns, the authors used “multiple approaches” that are not likely influenced by “strategies of dispersed traders, trading characteristics, or asset class specificities.”
“Our first key finding is that wash trading exists extensively on unregulated exchanges but is absent on regulated exchanges,” they wrote. “We consistently find anomalous trading patterns on unregulated exchanges only, with Tier-1 exchanges failing over 20% of tests and Tier-2 exchanges failing over 60%.”
In addition to identifying which exchanges regularly engage in wash trading, the authors also quantified the share of total wash trading volume represented on each exchange.
“We find that washing trade volume, on average, reaches 77.5% of total trade volume on unregulated exchanges, with a median of 79.1%,” they wrote. “Notably, laundering trading on the twelve tier 2 exchanges is estimated to account for over 80% of total trading volume, which is still over 70% after accounting for the observable heterogeneity of trading.”
The authors wrote that these percentages account for more than $4.5 trillion in wash trading in spot markets and more than $1.5 trillion in derivatives markets in the first quarter of 2020 alone.
They also measured the impact of wash trading on a stock’s ranking. Using historical rankings and trading volume information from CoinMarketCap, the authors showed that exchanges whose total reported volume was 70% of wash trading moved up 46 positions in the rankings.
They also found that an exchange’s wash trading is positively correlated with its short-term quoted cryptocurrency prices, and that more established exchanges with more users wash less, while smaller exchanges “have short-term incentives to wash trading without drawing too much attention.” They added that wash trading is predicted positively by returns and negatively by price volatility.
The authors noted that they saw very little evidence of wash trading on regulated exchanges. “While current corporate incentives and rating systems fuel rampant wash trading on unregulated exchanges, regulated exchanges, having committed considerable resources to compliance and licensing and facing severe penalties for market manipulation, do little wash trading,” they wrote.
They conclude that this study provides “a cautionary tale to regulators worldwide” and highlights the importance of regulation in emerging industries, the importance of adjusting volumes to account for wash trading in other studies, and “the utility of statistical tools and behavioral benchmarks for forensic finance and fraud detection.
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