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  • According to a study, wash trade accounts for 70% of trades on some crypto exchanges.
  • The practice of companies negotiating with themselves to artificially raise prices can attract inexperienced investors.
  • Three experts dive into the practice and what it means for the crypto market.

Illicit crypto transactions have exploded in 2022 as crooks and hackers won with billions, but there is another type of fraud lurking in the industry – wash trade, the fraudulent practice that some crypto traders and firms may use to pump prices, dupe investors and make the more liquid trade.

A recent working paper from the National Bureau of Economic Research found that washout transactions accounted for up to 70% of all transactions on non-compliant crypto exchanges, suggesting that most transactions on these platforms are fraudulent. Marc Cubanan avid cryptocurrency investor, has warned his followers that the discovery and regulatory crackdown on washout transactions could potentially trigger another implosion in the industry.

What is wash trading and why is it bad?

According to Timothy Cradle, Director of Regulatory Affairs at Blockchain Intelligence, washout trade is basically when a company or party negotiates with itself to artificially raise prices, give the illusion of liquidity and generate interest from others. investors. This may cause other investors to buy the token at an artificially high price. It is fraud and a form of market manipulation, he said.

But the practice isn’t just limited to individual bad actors. Crypto exchanges may also perform washout operations to artificially increase trading volumes, making the exchange more productive or more liquid than it actually is. This could potentially attract investors looking for a place to park their money, especially if they are comparing exchanges.

“There is competition in every industry. That’s no excuse to go out and wash trade and try to make your exchange more liquid than it really is, especially when dealing with cryptocurrency,” Cradle said.

What is its frequency?

Wash trade could be as simple as sending crypto from one wallet to another, but there are more elaborate schemes, says Kim Grauer, director of research at Chainalysis. In his research, wash transactions were identified when a transaction met certain criteria for a relationship with other wallets and addresses, suggesting that something fraudulent might be taking place.

The NBER article studied 29 crypto exchanges categorized as either regulated or unregulated, with unregulated exchanges categorized into two tiers based on their size. The authors found that wash trading was virtually absent on regulated crypto exchanges, but averaged 77.5% of trading volume on unregulated exchanges. Tier 1 unregulated exchanges had a slightly lower proportion of sham trades at 61.8% of trades compared to 86.2% of trades on Tier 2 unregulated exchanges.

For Binance, the world’s largest crypto exchange by trading volume and an unregulated Tier 1 exchange in the study, wash trade was estimated at 46.4% of all trades.

“Binance does not engage in or condone wash trading, which is a violation of our Terms of Service, and never has,” a spokesperson for the exchange told Insider. “Binance has a dedicated market surveillance team that is responsible for reviewing surveillance related to potential abusive and/or manipulative behavior, including sham trades and manipulation of trade prices.”

KuCoin, another top five crypto exchange according to CoinMarketCap, was estimated that 52.9% of its transactions consist of washing operations. An exchange spokesperson told Insider that KuCoin did not engage in the washout trade.

The paper also found a higher washout trade incident within a few weeks after the crypto market saw positive returns or experienced a drop in volatility. “Price increases could attract the attention of retail investors and encourage speculation. Therefore, crypto exchanges have an incentive to increase volumes to compete for higher rankings and more customers.”

According to Martin Leinweber, digital asset product specialist at MarketVector Indexes, there is no way to truly identify a fictitious transaction unless you have access to account data, which is usually only available to exchanges. themselves. The paper’s findings, however, give an idea of ​​the importance of regulation in the industry, he said.

How bad is this for the crypto industry?

Experts are hesitant to say this could lead to the crash envisioned by Mark Cuban, though the risk of another major crypto exchange going down due to fraudulent behavior is certainly possible, Cradle said.

“I find it hard to agree or disagree with that,” Cradle said. “I would be hard pressed to see a complex industry completely disappear because of some type of fraud or manipulation.”

“I don’t see a risk of a sudden crash as investors are already migrating to better exchanges,” Leinweber added, noting the exodus of crypto traders to Tier 1 exchanges, which generally have better external ratings and are more comply with regulations.

Why aren’t regulators paying more attention?

One problem could be that the legal framework for crypto regulation is currently ambiguous. For example, many industry players have asserted that cryptocurrencies are commodities, not securities. But this definition puts crypto into a regulatory loophole, as there is no federal oversight of the commodity spot market as there is for the futures market.

“We’re in this weird situation where the CFTC and the SEC haven’t really defined what cryptocurrency is, and the question is who is actually going to investigate it and why,” Cradle said.

Others criticized the CFTC and SEC’s hands-off approach to regulation. SEC Chief Gary Gensler has previously said that the United States has a regulatory framework for crypto businesses, but many do not complyhe said, urging exchanges to “come in and talk.”

Leinweber speculated that regulators might need a more comprehensive strategy if they really want to crack down on bogus trading.

“To govern these exchanges, you need to have an overall strategy. Otherwise, regulatory arbitrage would still exist,” he said. “I predict there will be increased regulation. But what we really need is smart regulation.”



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