28 May, 2023

What Is Crypto Wash Trading, And How Does It Work?

what is crypto wash trading

TLDR

This guide will give you a better understanding of crypto wash trading and how to detect it.

Crypto wash trading is like the Wild Wild West of market manipulation! A trader will buy and sell the same digital asset, artificially inflating the volume and price. Then a sucker buys the crypto, and the money is clean.

It’s like they’re waving a magic wand, appearing with activity and interest in the market. But, just like a magic trick, it’s all an illusion.

These wash trades often generate false and misleading buy and sell signals to manipulate markets. While they are tricking other traders and investors into thinking there’s a demand.

Introduction

In the crypto space, we’ve heard a lot of hacks that led to losing millions of dollars. Scammers have also had their hands deep in illicit crypto transactions and fraudulent activities that exposed the crypto wash trading, especially in cryptocurrency exchanges.

These illegal, unregulated crypto transactions have engineered the fall of cryptocurrency exchanges, including FTX.

In short, we have been through a lot of turbulence, and wash trading has been one of the reasons. Don’t worry. We will share all the secrets with you so you are well-equipped.

Wash trading inflates the price artificially.
Wash trading inflates the price artificially.

What is wash trading in crypto?

Wash trading crypto or round trip trading is a type of market manipulation. A firm or trader artificially buys and sells cryptocurrency to inflate the price.

Wash-traded trades generate false and misleading buy and sell signals to trick other investors.

This often entices new investors and creates a false sense of market activity. In traditional finance, wash trading is illegal. Since crypto is still an unregulated niche, wash sales have no legal requirements.

In lay terms, imagine you own and run a grocery store. However, you buy and sell to yourself as a customer to increase sales volume. Since there is higher demand, you can increase the sales price. You do all this to woo investors to invest in your grocery store.

Crypto Wash Trading Report

Crypto wash trading report revealing the real concerns.
Chain analysis reveals the real concerns.

An article from the National Bureau of Economic Research shows that wash trades account for up to 70% of all trades on non-compliant bitcoin and cryptocurrency exchanges.

This means that most of the transactions on these platforms are fraudulent. This leads to intense scrutiny of high-frequency trading and high-frequency traders by cryptocurrency regulators

High-frequency trading, a form of algorithmic trading, involves the automatic buying and selling of significant volumes of money and digital assets or currencies at extremely high speeds.

Most major unregulated crypto exchanges feature excessive wash trading,

“We estimate the average wash trading to be 53.4% of trading on unregulated Tier-1 exchanges and 81.8% on Tier-2 exchanges.”

Tier-2 exchanges were mainly founded during 2017 and 2018, while those in Tier-1 were older.

Chainanalysis – Crypto Wash Trading report, Feb 2022.

How Does Wash Trading Work

A Forbes survey of 159 cryptocurrency exchanges found that more than half of Bitcoin transactions were considered fraudulent or uneconomic. 

How Does Wash Trading Work
Bitcoin fraudulent transactions.

Pump and dump schemes

Cryptocurrencies are especially volatile against pump-and-dump schemes. A combination of inflated trading volume, advertising, and internal sales artificially inflates the value of tokens. This allows certain holders to sell them for huge profits while interest is high.


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NFT wash trading

You can also wash trade with NFTs.

It is done by setting up multiple crypto wallet addresses to buy and sell the same NFT. Consequently, they appear at a higher price than they are worth. The address of the purchase and sale is the same. Since transactions between wallet addresses are stored on the blockchain, anyone can see when an NFT is increasing in price. That is how to wash traders’ benefits.

However, wallet addresses do not contain identifying information. These appear as alphabetical strings, making determining who is behind the transaction difficult. That makes detecting whether the same person has two wallet addresses harder.

Examples of Crypto and NFT wash trading.

Crypto Punk

The saga of CryptoPunk 9998 started on Oct. 28, 2021. Cryptopunks are considered the Bitcoin in NFTs as the first original collectibles.

CryptoPunk 9998.
CryptoPunk 9998.

CryptoPunks Bot automatically monitors and tweets about CryptoPunks transactions and reports the sale of the white-haired, green-eyed, pixelated character.

List of CryptoPunks wash trading
List of CryptoPunks.

CryptoPunk 9998 was traded between two Ethereum wallet addresses. Less than two hours later, the Punk’s new address moved it on again, selling it for 124,457 ETH ($532 million). All of the funds were borrowed.

However, the merry-go-round didn’t stop there.

The buyer transferred the spent ETH to the seller, who immediately returned it to repay the loan originally used to purchase the female Punk.

The impact of washing trading on the crypto market

NFT wash trading has become a concern due to its interference with the concept of beneficial ownership. Beneficial ownership means any NFT owner with legally beneficial ownership refers to all of the same NFT’s intellectual property securities. This means the NFT space has no common beneficial ownership.

The impact
NFT/Crypto wash trading.

Wash trading makes it difficult for NFT enthusiasts to gauge the genuine market interest in NFT portfolios. It also increases or changes the volume of trades in the market to deceive analysts about what is happening on the trading platform.

The NFT washing business is one of the biggest hurdles in valuing projects and assets in the NFT industry. It includes NFT collections regulated exchanges, NFT tertiary tokens, and studios and developers bringing their products to market.

How to Detect NFT Wash Trading

Observing non-fungible token (NFT) trades reveals several indicators of suspicious activity. A potential sign includes an NFT at a specific address undergoing multiple daily trades, with all other settings remaining unchanged.

This could indicate that the person or group behind the address specifically targets a particular NFT and may be artificially the same security by multiple sources, trying to inflate its value.

How to Detect NFT Wash Trading
High NFT transactions between 2021-2022.

Another sign of suspicious activity is when the same address trades the same individual NFTs with high frequency. This could indicate that the person or group behind the trading address is trying to manipulate the market for that NFT.

Another red flag is when NFT sets are often sold without advertising or marketing behind the sale. This unusually high trading volume may indicate manipulative activity.

Additionally, if the same wallet funds the suspicious wallets, this is a sign that the same group is behind.

Finally, suppose the sale price of a traded NFT is significantly higher than the lowest NFT price in the market for a short period. In that case, it may indicate an artificially inflated price.

In general, it is important to exercise caution when trading NFTs. Watch out for suspicious activity that may indicate market manipulation or fraud.

Regulators Take Action to Protect Investors

The practice of trade laundering, in which individuals or groups artificially increase the trading volume or trading volume in the cryptocurrency market, has become a significant concern in the cryptocurrency industry.

Regulators protecting investors.
Regulators are protecting investors.

Regulated and unregulated exchanges work with the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to curb this illegal activity and protect potential investors from capital loss.

Since passing in 1936, The Commodity Exchange Act has undergone numerous amendments. This is to adapt to the cryptocurrency industry and curb illegal activities. Mainly, targetting cryptocurrency exchanges may engage in manipulating the cryptocurrency market.

The Wash Sale Act allows investors to buy and sell securities or assets from traders using their money or bitcoins to achieve their accurate price or value rather than traders suffering from illegal trading.

Securities bought and sold through wash sale rules show interest and falsely high demand in global financial markets. It must meet the minimum requirements of the CFTC and SEC.

Regulators enforce stricter rules to ensure that wash trading does not occur in the cryptocurrency industry and protect investors from capital losses. Investors must exercise due diligence and be vigilant when buying or selling crypto assets.

Crypto Wash Trading: Our Verdict

In conclusion, wash trading is when a trader repeatedly buys and sells the same asset, making it look like there’s a lot of activity and interest in the market. But, just like a magician’s trick, it’s all an illusion.

The problem with wash trading is that it’s illegal and often used to deceive new investors. The trader using wash sale artificially inflates the asset’s price, making it look like a first investor buys it at a great deal. But, once the new investors buy in, the asset’s price drops, and they’re left holding the bag.

Unfortunately, this market manipulation is less regulated in the crypto industry than in traditional finance. But, the authorities are cracking down on parties involved in this shady practice. Authorities have served notices to cryptocurrency exchanges found to be illegally wash trading, instructing them to cease their illicit activities.

The crypto market needs tighter regulations and oversight to safeguard investors and maintain market fairness and transparency. As an investor, you must do your due diligence and not make rash decisions to buy a security.

Don’t be fooled by the wash trading magician’s trick; do your research and invest wisely.