Updated: May 19, 2020
How is wash trading identified?
Wash trading can be identified in different ways. One of the easiest ways to determine if an exchange is participating in wash trading is to compare the number of viewers on the exchange to the exchange’s trading volume. If there are large discrepancies, such as an extremely large trading volume per viewer, this indicates possible wash trading. Another way is to compare the time it takes for an account/address to purchase and sell digital currency. If the time is almost instantaneous, this could show the activity of a bot account which quickly buys and sells in order to increase the trading volume of an exchange – this can also be tied to a comparison of similar buy and sell orders from the same exchange as it is unusual for users of the same exchange to buy and sell the same amount of digital currencies at the same time, which is another indicator of bots. Several exchanges and groups have suggested potential mechanisms be put in place to prevent exchanges from participating in wash trading; although, it has yet to be seen if the smaller, unregulated exchanges will accept these suggestions and go the route of becoming a reputable exchange to compete with the larger ones.
Why should crypto-traders care about wash trading?
Traders should care about wash trading because it can give them an insight into potential market manipulation occurring around certain coins and exchanges. By having knowledge about wash trading, such as what coins are being manipulated and where it is occurring (i.e., which exchanges) can allow a trader to make better-educated trades, or to not trade at all, as the price surrounding a specific coin may be influenced to increase or decrease based on the particular manipulation. This knowledge may also allow them to stay away from certain exchanges that take part in wash trading as they will know that those exchanges may not have better pricing or may not be reliable.
Will wash trading continue to decline in the crypto space?
Over time, due to the increase in regulatory trader protections, transparency, and overall use, I believe that wash trading will decline over time as the digital currency industry continues to mature. Currently, the larger exchanges do not participate in wash trading and as the industry evolves users will tend to join the larger and more transparent exchanges, or alternate trading systems (ATS) that have the best reputation and are keen to stay away from wash trading; once an exchange has been found of participating in wash trading, users spread the word and those exchanges end up with significantly fewer users. I do not believe, however, that wash trading will disappear entirely as there will always be users that try to manipulate coin prices (typically smaller coins with lesser trading volumes) or smaller exchanges that try and attract users (typically those that are new to the industry). It is noteworthy that even in the case of established and heavily regulated stock exchanges, one still occasionally hears about price manipulation attempts. While one cannot completely eliminate such behavior, through vigilant oversight one can reduce it to an insignificant level so the integrity and the credibility of the trading institutions are not impugned.
How has wash trading in the crypto-space changed throughout the years?
As many of the smaller, unregulated exchanges are being caught of participating in wash trading, many users are staying away from those exchanges. As such, there has been a decrease in wash trading around the industry. Additionally, as this becomes a more well-known issue for newer traders, they tend to join the larger more reputable exchanges that stay away from any activity that can negatively impact their user-base and therefore trading volume. As more time goes on, there are more indicators and groups that investigate wash trading in order to protect traders and price manipulation.
I suspect that one of the primary reasons that wash trading has decreased in 2019 is due to the numerous organizations and reports that have put a spotlight on this form of market manipulation. At the beginning of the year, many reports began circulating that the majority of digital currency trading volume was fake and that popular sites such as CoinMarketCap (CMC) show the full trading volume that is not accurate to the market. Consequently, many organizations began analyzing exchanges to determine which ones participated in wash trading. The exchanges that were found of having participated in wash trading lost their reputation and other exchanges decreased participation to prevent from being discovered. Regulators have also begun targeting smaller, unregistered exchanges to protect traders. Lastly, analytical sites such as Messari have begun listing information that offers increased insight into “real” trading volumes to provide a better reflection of the industry.
What function does wash trading serve?
Wash trading is a form of market manipulation as it feeds misleading information to the market. This effectively influences the price of coins and can lead to changes in market sentiment surrounding that coin. Wash trading is also used by certain exchanges, generally smaller ones, to try and attract new users as they can show an increase in trading volume from their exchange. This leads potential traders to their exchange in the guise that other traders are also going there or are utilizing that exchange due to factors such as faster transactions or better coin prices. It can also attract digital currency issuers to list on that exchange.