Wash trading is a deceptive practice that aims to create artificial trading activities to mimic genuine market conditions. Its goal is to make it seem like there’s a flurry of trading happening, fooling regular traders into thinking the market is bustling. Those who engage in wash trading could be external parties or even insiders with vested interests.
This kind of fake trading occurs in various financial markets, both large and small. While its origins lie in traditional financial markets, wash trading also happens in cryptocurrency markets.
In a report from 2022, researchers examined Bitcoin trading across 157 crypto exchanges. They discovered that as much as 51% of those transactions were actually wash trades.
Stopping wash trading is tough, mainly because the regulations surrounding cryptocurrencies are not very clear. However, if left unchecked, it could seriously hurt the growth of the crypto market and make it hard for people to use cryptocurrencies.
Why? Because it puts regular people who invest their money at a higher risk than they should be, potentially leading to significant losses.
This article aims to help you understand what wash trading is, teach you how to spot signs of it, and provide strategies to help you avoid falling victim to this type of market manipulation.
What Is Wash Trading In Crypto?
Wash trading in the cryptocurrency world refers to the artificial inflation of trading volume for specific cryptocurrencies and, in some cases, crypto exchanges themselves.
In the crypto market, the credibility of exchanges often depends on their trading volume. Higher trading volumes usually imply reliability, as traders prefer platforms with lots of active transactions.
This dynamic can nudge exchanges to manipulate trading volumes to create an illusion of trustworthiness and attract legitimate traders to their platforms.
In some cases, investors holding a large chunk of a cryptocurrency’s total supply may also engage in wash trading. With control over a substantial part of the circulating supply, these investors can shape market conditions to their advantage.
They trigger “panic selling” by selling large portions of their holdings, inducing other traders to do the same. Capitalizing on the subsequent price drop, these manipulators buy back the cryptocurrency in large quantities at reduced rates.
This strategy often tricks unsuspecting traders into buying the cryptocurrency due to the fear of missing out (FOMO). Eventually, this leads to a scenario where the manipulators artificially raise the price and then quickly crash it, known as a pump-and-dump scheme – a type of wash trading.
Another commonly used wash trading tactic involves a wash trader creating multiple accounts. These accounts then trade with each other, making it seem like different traders are involved.
What’s The Motive Behind Wash Trading In Crypto?
People have their different reasons for diving into wash trading; however, these two stand out:
To Create Illusions of High Activity and Liquidity
Developers of new crypto tokens, especially memecoins, often resort to wash trading to make it look like their token is being heavily traded. Their goal is to spark more interest and FOMO among unsuspecting crypto traders.
To Influence Market Trends
Wash traders, who hold substantial amounts of a cryptocurrency’s total supply, can influence market trends. For instance, if a token holder controls around 20% of the total token supply and decides to sell their tokens, other traders might see this as a big sell-off and decide to sell their own tokens too.
This kind of reaction often causes a price dip, which the wash trader capitalizes on by buying up the tokens flooding the market at a lower price. Later, as the buying pressure builds, they can either push the price back up or repeat the sell-off to steer the market in their desired direction.
How Can You Detect Wash Trading In Crypto?
Detecting wash trading in crypto requires collaboration between traders and exchanges committed to maintaining the industry’s integrity. Although spotting wash trading can be a bit tricky, there are a few simple ways to go about it:
1. Monitor Trade Volume in Low-Cap Cryptocurrencies
Wash traders often target low-cap cryptocurrencies as they’re much easier to manipulate. Keep an eye out for unusually high trading volumes in cryptocurrencies with low market capitalizations. If you notice a significant surge in trading volume without any accompanying news or developments, this could be a sign of wash trading.
2. Be Cautious of Unregulated Exchanges
As a rule of thumb, avoid trading on unregulated exchanges, as they are more likely to enable and perpetuate wash trading. According to a report from the National Bureau of Economic Research, centralized exchanges of this nature have approximately 70% of their total trading volume attributed to wash trades.
While clear-cut regulations for crypto trading are still evolving, it’s safer to stick with popular exchanges that commit to following potential regulatory guidelines.
3. Look out for Irregular Buying and Selling Patterns
Wash traders often rapidly buy and sell a cryptocurrency within a short timeframe. Be on the lookout for repetitive or sudden spikes in trading that don’t match market fundamentals. These irregular patterns may indicate wash trading attempts to create artificial volume and manipulate prices.
4. Stick to Trustworthy Exchanges
Only use reputable and regulated exchanges that prioritize transparency and regulatory compliance. These exchanges are more likely to implement measures to detect and prevent wash trading. Regular audits, KYC (Know Your Customer) procedures, and adherence to regulatory standards can help limit the risk of wash trading.
5. Stay Informed
Stay updated on news, market trends, and developments within the industry. Having in-depth knowledge of the projects and cryptocurrencies you invest in can better help you assess the legitimacy of trading activities and identify signs of wash trading.
Remember that these signals aren’t foolproof, and there can be false alarms. If you suspect wash trading on a specific exchange, consider reporting your concerns to the exchange itself and alert the crypto communities you’re part of.
Is Wash Trading Illegal In Crypto?
Wash trading is widely considered unethical and detrimental to market integrity. It is regarded as a form of market manipulation in traditional financial systems and is typically illegal in many jurisdictions.
However, the cryptocurrency industry still lacks comprehensive regulation, leading to a lack of explicit definitions regarding the legality of wash trading.
Consequently, the legal status of wash trading in the crypto market can differ depending on the specific jurisdiction and regulatory framework in operation.
Why Wash Trading is a Big Problem for Crypto
A huge chunk – around 70% – of the trades happening on unregulated crypto exchanges in 2022 were reportedly wash trades. This is a big deal and, if left unchecked, poses serious risks to the cryptocurrency market. Some of these consequences include:
Distorted Market Picture
When so much trading is fake, it’s difficult to tell what’s happening in the crypto market. This makes it difficult to track the actual growth rate of crypto projects and undermines the concept of a fair market.
Unchecked/Uneven Financial Losses
Wash trading only benefits the people doing it. Unfortunately, unsuspecting investors caught up in it may suffer significant losses, as they might end up buying or selling cryptocurrencies at prices that don’t show the true market value..
Fraudulent activities like wash trading hurt the reputation of the crypto industry. If these dishonest practices continue unabated, people wanting to get into crypto trading might be put off. They might not trust the information they get about the market, which can stop them from getting involved.
Increased Regulatory Scrutiny
The cryptocurrency industry is already under increased regulatory scrutiny, with various regulatory bodies worldwide attempting to determine their position on its activities. Fraudulent practices such as crypto wash trading may create an unfavourable environment for the development of reasonable industry regulations.
Consequently, the risk looms that stricter regulations might be imposed, making it harder for regular folks to get involved in crypto.
- Regulatory bodies and authorities are cracking down on fraudulent activities in the crypto market. They may employ existing regulations, such as anti-fraud and anti-manipulation laws, to prosecute individuals or entities involved in wash trading.
- Furthermore, crypto exchanges face mounting pressure to uphold equitable and transparent trading environments. Several reputable exchanges have taken steps to identify and prevent wash trading, driven by the desire to establish trust and meet regulatory requirements.
- Nonetheless, the responsibility still rests on investors and traders active in the crypto market to equip themselves with a solid understanding of wash trading. This knowledge helps them spot it when it happens and reduces their risk of falling victim.
Disclaimer: This article is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence.
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