One year has passed since Sylvain Ribes shed a spotlight on the extent of wash trading among major cryptocurrency exchanges, detailing his belief that more than $3 billion in volume in early 2018 was fabricated. Specifically, Ribes identified OKex as the primary culprit, responsible for nearly 93 percent of its volume non-existent.
Since then, the exchange landscape has changed significantly concerning the emergence of new major players and the proliferation of smaller exchanges. However, wash trading has remained a concerning problem, as a recent report by CoVenture details. According to the report, which cites the Blockchain Transparency Institute (BTI) as a source, many exchanges only have less than one percent of their reported volumes for the top 25 BTC trading pairs.
Wash Trading and Why It’s So Prevalent in Crypto
Wash trading is a market manipulation method designed to artificially inflate the volume of an exchange to show that it is more liquid — a principal attraction to investors. Under U.S. law, wash trading is illegal, as it feeds misleading information to the market.
There any several avenues by which crypto exchanges engage in and promote wash trading, from transaction mining exchange models to high API trading that misrepresents the true volume on an exchange. The incentives for exchanges to encourage and participate in wash trading are evident and primarily twofold.
First, in the transaction mining exchange model, exchanges take a fee on ‘maker’ and ‘taker’ trades but refund the fees paid to traders directly in the native token of the exchange. This causes demand for the exchange tokens which often have advantages like reduced fees, exclusive ICO access, or voting rights. Exchanges subsequently benefit from increased trading deriving from the incentive for traders to hold or sell the native exchange token they receive in return for trading on the platform.
Per the CoVenture report, transaction mining exchanges like Bit-Z have skyrocketed up the exchange volume charts — indirectly incentivizing wash trading bots to rush to the platform for net-zero trading fees. CoVenture cites that transaction mining exchanges only account for roughly 12 percent of the total exchange volumes, however.
Second, inflating trading volumes via high API trading volumes is a reliable indicator of wash trading, according to the BTI. Most of the leaders on its Advisory List have API trading percentages (of overall volume) above 80 percent. When mobile usage and API Trading inordinately surpass web traffic going to an exchange, BTI classifies the exchanges as high-risk for wash trading and adds them to their Trading Advisory List.
Exchanges inflate these metrics to appear to have larger volumes on their exchanges for a simple reason — listing fees. BTI’s December 2018 report stated:
“Based on information we’ve received from many tokens in the space, the average project spent over $50,000 this year in listing fees from exchanges on our Advisory List. This adds up to an estimated $100,000,000 stolen in 2018 from the crypto ecosystem.. and with over 50 exchanges wash trading over 95% of their volumes, this is a 500K a year scheme, with some exchanges making over one million dollars this year just from collecting these fees.”
With such an enormous incentive to attract projects for the listing fees, it becomes clear why many smaller exchanges push wash trading with bots on their exchanges. Notably, BTI identifies that Binance, Liquid, and Bitfinex are the 3 out of the top 25 BTC exchange pairs that do not grossly wash trade their volume.
CoVenture mirrors the conclusions made by BTI that exchanges not actively engaging in wash trading tend to have low API trading and web traffic that corresponds to their reported volumes.
They identify that the lack of standardized global regulation enables crypto-crypto exchanges to promote wash trading and do not police artificial trading activity because of the financial benefits it confers. According to CoVenture:
“Loose regulations has led to many crypto exchanges engaging in secondary businesses that have traditionally been out of reach to traditional financial exchanges. These high margin businesses include ICO listing fees and internal proprietary trading. All of these business models depend on high volume for profits. Exchanges with high volume can charge the highest fees from ICOs who want to list on their platform, collect the most revenue from high trading fees, and have the liquidity and user data to prop trade on their own platform.”
Their summary adequately highlights what they refer to as the ‘chicken and egg problem’ in crypto. Traders seek exchanges with high volumes, so exchanges use marketing tools like airdrops, native exchange tokens, and ICO listings to encourage trading on the platform. The dynamic between projects, exchanges, and coin rankings sites leads to increase risk on the part of investors, with exchanges promoting altcoins essentially functioning as ‘altcoin casinos.’
CoVenture also cites how the concentration of trading on crypto exchanges is highly concentrated. The top 10 percent of exchanges account for 60 percent of spot volume, and the top 25 over 90 percent of total crypto spot volumes. Regulated futures exchanges that offer BTC futures in the U.S. — CBOE and CME — represent less than 3 percent of the crypto futures market.
Similar to BTI, CoVenture describes how discrepancies in the correlation between web traffic (i.e., using Alex Web Traffic Ratings) and average daily volume can reveal suspicious reported volumes from exchanges. Additionally, CoVenture details using order book depth to identify inconsistencies in reported volume in the capital necessary to deflate the price of a top 5 liquidity trading pair down 10 percent. For Bitfinex, considered to not engage in wash trading, it would require approximately $9.47 million to “crash the price of a top 5 market by 10 percent.” However, Coinbene, a smaller exchange on BTI’s advisory list requires drastically less capital, cited by CoVenture as:
“Coinbene reports similar 24 hr volume as Bitfinex on its top 5 markets, and yet it only takes $13,600 to crash the cryptocurrency price of the top 5 markets by 10%,” the report concludes.
CoVenture concludes that increasing regulation in the sector is necessary to push out exchanges engaging in wash trading. “We think that liquidity can ‘flush out’ a portion of the bad actors in the space as well as bring ‘institutional legitimacy’ into the markets,” they asserted.
The market inefficiencies caused by wash trading are problematic and endemic in the crypto industry. Even with the decline in ICO popularity, which should serve as a reduced incentive for exchanges to actively wash trade volumes, it is an ongoing and prevalent problem. Fortunately, reports by CoVenture and initiatives like BTI’s offer some accurate insights into the market that are not distorted by information inefficiencies.