Wash Trading: How Cryptocurrency Exchanges Fight It?

Wash trading isn’t a new phenomenon. This approach has been applied by traders to “cheat” the market and make stocks (or whatever is traded) appear to perform well. Many traditional methods of market manipulation have also found their way in the world of cryptocurrencies, meaning that there are individuals or groups who wash trade to achieve some goal.

Most of the time, wash trading is used to create an illusion that a certain asset is being actively traded. This way, new investors are attracted to putting money in it, mistakenly believing that the asset is popular.

Cryptocurrency exchanges are working hard on minimizing and possibly eradicating this type of manipulation. They are doing great so far, as the amount of wash trades has decreased by 35%, as stated by Bitcoin Magazine.

So, what exactly is wash trading in the cryptocurrency sphere, and how can exchanges fight it?

 

What is wash trading?

As we have mentioned before, wash trading is a market manipulation method. It usually involves an investor who buys and sells simultaneously in order to influence the market.

In this case, unfair trading takes place as the investor sets a sell order and then immediately buys from himself or herself. This is recorded as a trade, but things basically return to the way they were before the trade. Once the investor creates a series of “wash trades,” this can cause an activity meter to go up. As a result, new investors believe that the financial instrument is popular.

Wash trading can also involve investors and brokers who join forces to create fake trades. The actors usually create several succeeding orders which are immediately met with offers also created by those actors. That way, they create huge trading volume — and we all know that there’s a potential to profit from things that are actively traded.

 

Is wash trading legal?

Ever since it was first exploited back in the 1930s, wash trading has been banned by the US government. An act from 1936, which provides a framework for exchanging commodities, perceives wash trading as an illegal activity. Nowadays, this type of manipulation is banned all over the world. However, the cryptocurrency sphere, which is highly unregulated, has paved the way for similar attempts of market manipulation – some of which have been pretty successful.

Cryptocurrencies have been subject to various price manipulations, including wash trading. In fact, some exchanges were involved in this type of scheme to attract more users to register. In order to avoid worrying that exchange will pull a wash trade or other manipulation methods, you need to go for an exchange that’s both reputable and reliable.

 

Reliable exchanges: What are they?

Luckily, most platforms are licensed and regulated nowadays, meaning that they are obliged to fight all kinds of market manipulation.

Now, there are dozens of great exchanges out there. If you are new to cryptocurrency trading, then CEX.IO is probably a good fit as it allows to safely buy Bitcoin and top altcoins. It is both a legit and beginner-friendly platform that will unlikely risk its reputation and will make sure to minimize market manipulations. This is actually proven by the numerous compliance certificates that they possess. To fight any form of fraudulent activity, the exchange applies strict identity verification policies, performs KYC checks, and due diligence procedures. Other role models in the cryptocurrency sphere include Coinbase, Kraken, Bittrex, Binance.

Now, let’s take a look at how cryptocurrency exchanges could fight wash trading.

Self-trade prevention

One of the technical approaches to solving the problem is not allowing orders of one account to match with each other. Although this seems simple in theory, some platforms opted out of it since that would prevent experienced traders from getting the most of their cryptocurrency exchange. Namely, many savvy investors use one account to run a couple of strategies, and preventing self-trade would narrow down their options.

 

Single accounts for traders and institutions

Some traders and institutions open several accounts on a single exchange which paves the way for possible manipulations. By restricting them to one institutional account, cryptocurrency exchanges could significantly lower the possibility of wash trades taking place.

 

Detection of odd trades

If someone places a couple of orders that are immediately matched, there’s a slight probability that someone is trying to manipulate the market, especially if these orders are consecutive. Exchanges should use AI tools that can detect patterns, which are common in wash trading, and inspect them to determine whether someone tried to manipulate the market or not.

 

Keeping things transparent

One of the best things an exchange can do to prevent any kind of market manipulation is to invest in security and transparency. If they are transparent enough, people who want to pull off wash trading will avoid them as they could be easily detected.

 

Measuring the time it takes for an order to finalize

One of the interesting wash trading prevention measures that Hacker Noon suggests is putting “time heuristics for consecutive orders.” In plain English, exchanges know how much time it takes for an order to be processed and become available. If there are some inconsistencies exchanges should inspect for possible manipulation attempts.

 

Conclusion

To sum up, the overall state of affairs in the cryptocurrency market is getting better. It is steadily becoming regulated – step by step. There is still a lot of room to manipulate the market though, so you should always be careful. The best thing you can do is choose a secure and transparent exchange that does its best to fight wash trading and other shady practices.

With some improvements, things will, hopefully, get even better. After all – unlike 1936, we now have technology on our side and should make the most of it.

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