In July 2019, Alameda Research, in collaboration with FTX Global published a report which claimed 68% of the trading volume reported on CoinMarketCap to fake. Before this, in May 2019, Bitwise Asset Management submitted a report to SEC in which they claimed this same percentage to be 95%. If the number ‘95%’ is true, it clearly exposes the scandal occurring in the crypto markets where exchanges are manipulating and reporting false figures only to attract more traders and play their market gimmicks. According to Bitwise’s report, only 10 exchange have ‘actual’ trading volume. These exchanges are in the figure below:
Source — Bitwise Asset Management
CoinMarketCap has also started displaying two different columns for adjusted volume and reported volume where adjusted volume is the volume remaining after removing malpractices like wash trading. To proceed further in this article, we will start with understanding what wash trading is.
According to Investopedia:
Wash trading is a process whereby a trader buys and sells a security for the express purpose of feeding misleading information to the market. In some situations, wash trades are executed by a trader and a broker who are colluding with each other, and other times wash trades are executed by investors acting as both the buyer and the seller of the security.
In simple words, I sold myself 10 apples and claimed it in my financial reports that I sold 10 apples and made profits. With cryptocurrencies and their exchanges, it is no different. Exchanges will shift funds from one account to another and charge the trading fee to themselves and claim the trading volume for this fake circulation. These transactions cancel or wash each other out and this is why they are called ‘wash’ trades. Investors and other traders can also be responsible for wash trading with the sole intention of manipulating the markets. These traders send consecutive orders to the opposite sides of the book at the same price with the same size, The trading engine executes this disguised order instantaneously. These orders are sent by traders (or bots) in quick succession to prevent the orders unintentionally “leaking” to the market.
Millions of dollars of fake volume are created by the exchanges daily by installing automated mechanisms that have no other tasks than circulating tokens within these wallets. The heights to which these exchange volumes are faked is ridiculous. Users go to CoinMarketCap and rank the exchanges based on trading volume to see which exchanges they should trust and where they can get instantaneous order executions because if there is one thing traders highly demand from exchanges is sufficient liquidity to execute their trades lightning fast. Hence, it is certainly claimable that to trust an exchange, their reported trading volume is one of the last things to look at since it is so effortlessly manipulable without the participation of any third party.
But other than producing a marketing gimmick, why are exchanges faking their trading volumes with wash trades.
Other than trading fees, one major source of income for exchanges is the listing fee they charge cryptocurrency projects to list their tokens on the exchanges. Exchanges are charging these companies hundreds of thousands of dollars as their listing fees. Binance, for example, have transparently listed their fee structure for projects to list their tokens on their exchange:
Fee structure for listing tokens on Binance (Source — Binance)
This image is sufficient to give an idea of the exorbitant fees you have to pay these top cryptocurrency exchanges to bring your tokens listed in their trading network. Exchanges charge projects based on the trading fee they can potentially achieve with exchange services. These exchanges are self-regulated and are not responsible to any regulatory authority or auditing firm to produce reports on their exchange activities. These exchanges do their own due diligence of the projects and after self-evaluation, they list these tokens on their exchanges. These tokens gain value in the network only after they come in circulation in the exchanges. Exchanges inflate their trading volumes to attract these projects and empty their pockets by promising them millions of dollars of monthly trading volume in return. These projects are not shy of paying the exchanges this lofty sum because in the fundamentals of tokenomics, the value of tokens is decided by the network and these exchanges are the marketplace that provides the network of buyers and sellers.
The next question arises what are exchanges doing to solve this issue and whether the exchanges are willing to solve them.
- Exchanges need to stop conducting trading games because the winners of these games are awarded based on the trading volume they have generated and in order to win the prize, the traders are tempted to conduct such malpractices.
- Exchanges need to drop their ‘tier’ or ‘level’ based fee structure (like we saw in Binance) and implement a single fee rule because implementing such technical solutions will prevent the basic need for better fee schedules which the listing projects expect from the exchanges.
- Exchanges need to make sure that the matched buy and sell order in the orderbooks do not belong to the same person. This will not prevent the user which is wash trading using multiple accounts but will add a precaution layer from the exchange’s side.
- Exchange need to implement strict KYC/AML practices which will prevent the traders from making multiple accounts on the same platform.
- Exchanges can make sure that the orders which are executing without appearing on the orderbooks should be canceled
While it is impossible to eliminate all fake actors from the ecosystem, a substantial portion of practices can be prevented if exchanges are proactively taking steps. It is completely unacceptable to turn a blind eye on such activities because they are misleading every layer of market participants which include retail and institutional traders, investors, companies, and governments. Such practices are holding cryptos to reach mass adoption as these scammy affairs inject more skepticism for the crypto industry. We appreciate the reports which are disclosing the exchanges favoring or suffering from wash trading practices. At the same time, we also hope the exchanges will take the required steps to block wash trading from their platform and keep the cryptocurrency markets honest and transparent, which is also an essential vision of Satoshi Nakamoto.