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- On some cryptocurrency exchanges, a study reveals that wash trades make up 70% of trades.
- The practice of companies trading with themselves to artificially drive up prices can attract inexperienced investors.
- Three experts detail the practice and what it means for the cryptocurrency market.
Illegal cryptocurrency transactions have surged in 2022 as scammers and hackers stole billions of dollars, but there is another type of fraud lurking in the industry. more liquid.
A recent research report by the National Bureau of Economic Research found that wash trades account for up to 70% of all trades on noncompliant cryptocurrency exchanges, with most trades on these platforms being fraudulent. suggests. An avid cryptocurrency investor, Mark He Cuban, has warned his followers that the wash trade discovery and regulatory crackdown could spark 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, wash trading essentially means that a company or party artificially pushes prices higher, creating the illusion of liquidity and allowing other investors to It is to make a deal to elicit interest from. This may cause other investors to buy tokens at artificially high prices. He said it was a scam and a form of market manipulation.
But this practice isn’t just limited to individual villains. Cryptocurrency exchanges can also use wash trading to artificially increase trading volume, making the exchange appear more productive and liquid than it actually is. It may attract investors looking for a place to deposit their money, especially if you are comparing exchanges.
“Every industry has competition. That is no excuse to go out and wash trade and try to make the exchange look more liquid than it really is, especially if you are dealing with cryptocurrencies,” said Cradle. said.
How common is it?
Wash trading may be as simple as sending cryptocurrencies from one wallet to another, but there are more sophisticated schemes out there, says Kim Grauer, research director at Chainalysis. In her research, wash trades were identified when trades met certain relationship criteria with other wallets and addresses. This suggests possible fraudulent activity.
The NBER paper examined 29 cryptocurrency exchanges classified as regulated or unregulated, with unregulated exchanges classified into two tiers based on size. The authors found wash trades to be virtually non-existent on regulated cryptocurrency exchanges, while they accounted for an average of 77.5% of trading volume on unregulated exchanges. Tier-1 unregulated exchanges had a slightly lower percentage of wash trades, at 61.8% of trades, compared to 86.2% for Tier-2 unregulated exchanges.
Binance is the world’s largest cryptocurrency exchange by trading volume and an unregulated Tier-1 exchange in the study, with wash trades estimated to account for 46.4% of all trades.
“Binance has never engaged in or tolerated wash trading that violates our terms of service,” an exchange spokesperson told an insider. “Binance has a dedicated market surveillance team, responsible for reviewing surveillance related to potential fraudulent and/or manipulative activity, including wash trading and manipulation of trading prices.”
Another top-five crypto exchange, KuCoin, is estimated to have 52.9% of its trades made up of wash trades, according to CoinMarketCap. An exchange spokesperson said Insider KuCoin does not conduct wash trading.
The paper also found a high incidence of wash trades in the weeks after crypto markets showed positive returns or after volatility subsided. “Rising prices attract the attention of retail investors and may encourage speculation. Therefore, cryptocurrency exchanges are encouraged to increase trading volumes in order to gain better rankings and more customers. I am motivated.”
According to Martin Leinweber, digital asset product specialist at MarketVector Indexes, there is no way to truly identify wash trades unless you have access to account data. But the paper’s findings show how important regulation is to the industry, he said.
How bad is this for the crypto industry?
Experts are hesitant to say it could lead to the crash envisioned by Mark Cuban, but the risk of another major cryptocurrency exchange going down due to fraud is certainly possible, Cradle said. said Mr.
“I’m torn between for and against it,” Cradle said. “I think it’s hard to see a complex industry completely collapsed by some kind of fraud or manipulation.”
“Investors have already moved to better exchanges, so I don’t think there is any risk of a sudden crash,” Reinweber added, adding that the outflow of crypto traders is typically highly externally rated and regulated. It pointed out that it is headed for Tier 1 exchanges that are more compliant.
Why aren’t regulators paying more attention?
One of the problems is that the legal framework for cryptocurrency regulation is currently ambiguous. For example, many in the industry argue that cryptocurrencies are commodities, not securities. But that definition traps cryptocurrencies into a regulatory loophole. This is because, unlike the futures market, there is no federal oversight of the physical commodity market.
“We are in this strange situation where both the CFTC and the SEC have not really resolved what cryptocurrency is and the question is who will actually investigate it and why? will be,” said Cradle.
Some have criticized the no-interference approach to CFTC and SEC regulation. SEC Chief Gary Gensler previously said the U.S. has a regulatory framework for cryptocurrency companies, but said many were not compliant, urging exchanges to “join and talk.”
Leinweber speculates that regulators may need to come up with a more comprehensive strategy if they are to truly crack down on wash trading.
“We need a global strategy to manage these exchanges, otherwise there will always be regulatory arbitrage,” he said. “I predict more regulation, but what we really need is intelligent regulation.”
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