Wash Trading Explained - Understanding and Identifying Manipulation
Explore wash trading in crypto markets, its impact, and how to identify and protect yourself from this deceptive practice. Stay informed and safe.
Wash trading is a deceptive market manipulation tactic that artificially inflates an asset's trading volume through simultaneous buying and selling by the same party. In cryptocurrencies, wash trading is a growing concern as it can distort market dynamics and create a false perception of an asset's popularity.
This article aims to shed light on wash trading in the crypto space, helping traders and investors understand its implications and learn how to identify and protect themselves from falling victim to such manipulative practices.
TL;DR
- Wash trading is a manipulative strategy for artificially raising the trading volume
- It involves buying and selling an asset by the same party
- Fraudulent schemes that use wash trading include Pump and Dump and fake exchange rankings
- Wash trading can be recognized by a high number of trades with little to no price movement
What is a Wash Trading?
Wash trading is an illegal practice where an individual or entity simultaneously buys and sells a financial instrument, such as a cryptocurrency, to create misleading market activity. This tactic is designed to manipulate an asset's trading volume and price, giving the impression of high demand and attracting unsuspecting investors.
By executing wash trades, manipulators aim to profit from the subsequent price movements when other market participants react to the artificially inflated volume. Some analysts, such as Mark Cuban, think that wash trading could be one of the significant upcoming issues of crypto.
Wash Trading Strategies
Various strategies are utilized in the field of crypto. Knowing and understanding these strategies can benefit you greatly. Crypto, because of its permissionless nature is known for high concentration of scams. Here are some schemes that utilize wash trading:
- Pump and Dump Schemes - wash trading is used to inflate an asset's price artificially before selling it off, leaving unsuspecting investors with losses as the price collapses.
- Exchange Rankings - Some crypto exchanges may manipulate reported trading volumes, creating a perception of liquidity and popularity to attract new users and projects.
Specific Examples
In the cryptocurrency market, wash trading has been observed in various instances, including NFT marketplaces and cases involving user rewards and airdrops. One example is the NFT marketplace LooksRare, where users were rewarded for their trading activity. In this case, wash trading became prevalent as users attempted to artificially inflate their trading volume to earn more rewards, leading to skewed market data and an inaccurate representation of the platform's popularity.
Another instance where wash trading plays a role is in meeting the trading volume requirements for airdrops. Sometimes, token issuers or exchanges require users to have a certain level of trading activity to qualify for airdrops. As a result, some users engage in wash trading to meet these criteria, creating fake trading activity and manipulating the market in the process.
Due to this artificial trading activity, many chain and/or crypto protocols may look like they are thriving, when in reality it is just a bubble for airdrop eligibility.
Effects on the Crypto Market
Wash trading has several implications on the overall crypto market, affecting various aspects of the ecosystem and shaping the perception of both experienced and new participants.
Market Perception
The artificial inflation of trading volumes through wash trading can create a false sense of popularity and liquidity for certain cryptocurrencies or exchanges. This misleading information can attract unsuspecting investors who may believe they are entering a thriving market.
Price Manipulation
Wash trading can distort the true price discovery mechanism, leading to price manipulation. As a result, asset prices may not accurately reflect their actual value, causing significant losses for traders and investors who rely on transparent market information.
Market Integrity
The prevalence of wash trading undermines the integrity of the entire crypto market. Investors may lose trust in the market, leading to reduced participation and limiting the growth potential of the industry.
Recognizing Wash Trading
Here are some common signs of wash trading that could help you distinguish project legitimacy. Be aware that some of these patterns may occur randomly and do not automatically mean wash trading. However, it should grab your attention when a project shows more than one of these signs.
Unusual trading patterns: Wash trading often results in irregular trading patterns that stand out from the market's typical behavior. For example, you might see sudden spikes in trading volume with little or no price movement.
Repeated trades at similar prices: A high number of trades executed at nearly the same price within a short time frame may indicate wash trading, as the manipulator is essentially trading with themselves.
Suspicious order book activity: Wash traders may place buy and sell orders at the same price or in close proximity, which can result in an unusually thin spread between the bid and ask prices.
You can easily use CoinBrain tools to conduct a simple trading analysis of a certain project. Choose the project you want to analyze (LDO for example) and open its CoinBrain profile. From there, you will have access to the analytical tools. Look for trading history on DEXs, suspicious chart patterns or large holder allocation.
FAQs
Is wash trading illegal?
Yes, wash trading is generally considered illegal in most financial markets, including cryptocurrency markets. Wash trading involves artificially inflating the trading volume of an asset by simultaneously buying and selling it to create the impression of market activity. This practice is prohibited by most regulatory bodies and can lead to market manipulation, which can harm investors and damage the integrity of the market.
What is wash trading in NFTs?
Wash trading in NFTs (non-fungible tokens) involves artificially inflating the trading volume and prices of specific NFTs through fraudulent trading activities. This can involve individuals or groups trading the same NFT back and forth among themselves, creating the illusion of high demand and price appreciation.
What is the difference between circular and wash trading?
Circular trading and wash trading are both fraudulent trading practices, but they are slightly different. Circular trading involves a group of traders buying and selling a specific asset among themselves to manipulate its price, whereas wash trading involves a trader buying and selling the same asset to create artificial volume and price movements. In circular trading, there may be a wider group of traders involved, while wash trading can be done by a single trader.
How does wash trading work?
Wash trading works by a trader buying and selling the same asset simultaneously or within a short period of time to create the impression of high trading activity. This can artificially inflate the asset's trading volume and price, leading other traders to believe that there is genuine market demand for the asset. In some cases, wash trading can be done using multiple accounts, with the trader buying and selling the asset among their own accounts to create the illusion of market activity. This practice can harm investors and damage the integrity of the market, which is why it is generally considered illegal.
