Illegal wash trading accounts for up to 70% of crypto volumes, finds study

A report from the US’ National Bureau of Economic Research finds that fabricated wash trading on unregulated crypto exchanges accounts for the lion’s share of reported volumes.  

Wash trading – the practice of creating artificially inflated trading volumes –gained traction (and headlines) with the rapid rise of electronic trading in the early 2010s, as algos and electronic trading programs became able to churn trades at unprecedented speeds. But cryptocurrency has opened up a whole new world of opportunity, which is having serious consequences on price transparency.  

A report from the National Bureau of Economic Research in the US, published in December 2022, found that illegal wash trading may account for almost three quarters (over 70%) of average trading volumes on unregulated exchanges.  

Researchers from Cornell University in the US, Newcastle University in the UK and Tsinghua University in China conducted systematic tests exploiting robust statistical and behavioural patterns in trading to detect fake transactions on 29 cryptocurrency exchanges. 

“Abnormal first-significant-digit distributions, size rounding, and transaction tail distributions on unregulated exchanges reveal rampant manipulations unlikely driven by strategy or exchange heterogeneity,” reported the study.  

These fabricated volumes, effectively the result of firms (and exchanges) illegally trading with themselves, can amount to trillions of dollars annually. The fraudulent practice can offer a false impression of liquidity, resulting in an improved (but inaccurate) exchange ranking, as well as temporarily distorting prices.  

But regulators are cracking down.

“Regulators – particularly in the US and the UK – are now deploying sophisticated market data analytics to identify all forms of market abuse, including wash trading,” said compliance and reporting specialist SteelEye. “Never before have regulators had such technology firepower at their disposal to combat market manipulation.”

Wash trading was first banned in the US in 1936 through the Commodity Exchange Act, while the Commodity Futures Trade Commission (CFTC) also prohibits brokers from profiting from wash trading, which it views as a form of market abuse. The US Securities and Exchange Commission (SEC) prosecutes wash trading through the Securities Act 1933 and the Securities Exchange Act 1934; while in the UK and EU the practice is banned under the Market Abuse Regulation.  

Now, the regulators are turning their attention to crypto markets, and prosecutions are on the rise. In March 2021, the CFTC fined Coinbase $6.5 million for “false, misleading or inaccurate reporting and wash trading”, claiming that between 2015 and 2018 the exchange operated two automated trading programs, Hedger and Replicator, which generated orders that at times with one another in certain trading pairs, resulting in trades between accounts owned by Coinbase. This “potentially resulted in a perceived volume and level of liquidity of digital assets, including Bitcoin, that was false, misleading, or inaccurate,” said the CFTC.  

“Reporting false, misleading, or inaccurate transaction information undermines the integrity of digital asset pricing,” added acting director of enforcement Vincent McGonagle. “This enforcement action sends the message that the Commission will act to safeguard the integrity and transparency of such information.” 

In the same month the UK’s Financial Conduct Authority (FCA) fined Adrian Horn, formerly a market making trader at Stifel Nicolaus Europe, £52,500 for market abuse and wash trading.