- Wash trading accounts for 70% of trades on some cryptocurrency exchanges, according to one study.
- The practice of firms trading with themselves to artificially raise prices can attract inexperienced investors.
- Three experts delve into the practice and what it means for the cryptocurrency market.
Illicit cryptocurrency transactions skyrocketed in 2022 as scammers and hackers ran off with billions, but there is another type of fraud lurking in the industry: wash trading, the fraudulent practice that some crypto traders and companies can use to drive up prices, deceive investors and make trading appear more liquid.
A recent National Bureau of Economic Research working paper found that wash trades account for up to 70% of all transactions on non-compliant cryptocurrency exchanges, suggesting that the majority of trades on these platforms are fraudulent. Mark Cuban, an avid cryptocurrency investor, has warned his followers that the discovery and regulatory crackdown on laundering trades could potentially create another implosion in the industry.
What is wash trading and why is it harmful?
Wash trading is essentially when a company or party trades with itself to artificially boost prices, give the illusion of liquidity, and generate interest from other investors, according to Timothy Cradle, director of regulatory affairs at Blockchain Intelligence. This can lead other investors to buy the token at an artificially high price. It’s fraud and a form of market manipulation, he said.
But the practice isn’t limited to just individual bad actors. Cryptocurrency exchanges can also wash trade to artificially boost trading volumes, making the exchange appear more productive or more liquid than it actually is. This could potentially attract investors looking for somewhere to park their money, especially if they’re comparing exchanges.
“There is competition in every industry. This is no excuse to go out and wash trade and try to make your trade more liquid than it actually is, especially when dealing with cryptocurrency,” said Cradle .
How common is it?
Wash trading might be as simple as sending cryptocurrencies from one wallet to another, but there are more elaborate schemes out there, says Kim Grauer, research director at Chainalysis. In researching him, wash trades were identified when an exchange met certain relationship criteria with other wallets and addresses, suggesting that something fraudulent might have gone on.
The NBER paper studied 29 cryptocurrency exchanges categorized as either regulated or unregulated, with unregulated exchanges sorted into two tiers based on size. The authors found that wash trading was virtually absent on regulated cryptocurrency exchanges, but made up an average of 77.5% of the trading volume on unregulated exchanges. Level 1 unregulated exchanges had a slightly lower percentage of laundering exchanges at 61.8% of transactions, compared to 86.2% of Level 2 unregulated exchanges.
For Binance, the world’s largest cryptocurrency exchange by trading volume and an unregulated Tier-1 exchange in the study, wash trading was estimated to comprise 46.4% of all transactions.
According to CoinMarketCap, KuCoin, another top five cryptocurrency exchange, has estimated that 52.9% of its transactions are laundering operations. A spokesperson for the exchange told Insider that KuCoin did not engage in wash trading.
The paper also found more wash trading in the few weeks after the cryptocurrency market posted positive returns or experienced a decline in volatility. “Price increases could attract the attention of retail investors and encourage speculation. Therefore, cryptocurrency exchanges have an incentive to increase volumes to compete for better positioning and more customers.”
There’s no way to truly identify a scrubbing exchange unless you have access to account data, which is typically only available to the exchanges themselves, according to Martin Leinweber, digital asset product specialist at MarketVector Indexes. The paper’s findings, however, give an idea of how important regulation is in the industry, he said.
How bad is it for the cryptocurrency industry?
Experts are reluctant to say it could lead to the collapse Mark Cuban envisioned, though the risk of another major cryptocurrency exchange going down due to fraudulent behavior is certainly possible, Cradle said.
“I have a hard time agreeing or disagreeing with it,” Cradle said. “I would find it hard to see a complex industry fail completely due to one type of fraud or manipulation.”
“I don’t see the risk of a sudden crash as investors are already migrating to better exchanges,” Leinweber added, pointing to the exodus of crypto traders to Tier 1 exchanges, which typically have better external ratings and are more compliant. to regulation.
Why aren’t regulators paying more attention?
One problem could be that the legal framework for regulating cryptocurrencies is currently ambiguous. For example, many in the industry have argued that cryptocurrencies are commodities, not securities. But this definition places cryptocurrencies in a regulatory loophole, as there is no federal oversight of the spot commodity market as there is for the futures market.
“We’re in this weird situation where both the CFTC and the SEC haven’t really settled on what cryptocurrency is, and the question becomes who is actually going to investigate it and why,” Cradle said.
Others have criticized the CFTC and SEC’s approach to regulation. SEC chief Gary Gensler has previously said the US has a regulatory framework in place for crypto firms, but many are non-compliant, he said, urging exchanges to “get in and talk.”
Leinweber speculated that regulators may need a more comprehensive strategy if they are to crack down on wash trading.
“To govern these exchanges, you have to have a global strategy. Otherwise, regulatory arbitrage would always exist,” he said. “I predict there will be more regulation. But what we really need is smart regulation.”