Wash Trading

Written by Evan Feng

Introduction

Wash trading refers to a form of market manipulation where an instrument’s volumes are artificially inflated intentionally to misrepresent higher liquidity than actually exists.

At a very basic level, this can be as simple as two accounts colluding to both buy and sell a given instrument at the same time, printing a trade which will ultimately get captured by exchange-level reporting and aggregator services. Individual projects may seek to overrepresent the amount of investor interest in their project by claiming two-sided markets exist in larger volumes than in reality and drive further price appreciation. At the same time, lower quality exchanges may be complicit or even participate in enabling or facilitating wash trading in an effort to show higher perceived levels of business success to further attract additional investors to onboard in search of the phantom liquidity that doesn’t exist in reality.

The traditional world of finance has a combination of market surveillance technology as well as anti-fraud laws in most developed world jurisdictions which effectively combat wash trading. As regulatory focus on digital assets and associated service providers (such as exchanges) grows, some of the anti-fraud and investor protection best practices may well make their way into the world of cryptocurrencies, further accelerating the bifurcation of legitimate venues away from the untrustworthy exchanges.

Suggested Reading

Investigation into the Legitimacy of Reported Cryptocurrency Exchange Volume by Alameda Research

Presentation to the SEC by Bitwise