Much of crypto trading on unregulated platforms could be fake, new research suggests

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LONDON, ENGLAND – DECEMBER 07: A visual representation of the digital cryptocurrency, Bitcoin on… [+] December 07, 2017 in London, England. Cryptocurrencies including Bitcoin, Ethereum and Lightcoin saw unprecedented growth in 2017, although they remained extremely volatile. While digital currencies across the board have divided opinion among financial institutions and now have a market capitalization of around $175 billion, the crypto industry continues to grow as it continues to see wider adoption. The price of one Bitcoin surged above USD 15,000 on many exchanges today, taking it above previous highs. (Photo by Dan Kitwood/Getty Images)

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If the scandal surrounding crypto exchange FTX wasn’t bad enough to scare all but the crypto diehards, there is now even more bad news for cryptocurrency investors.

Up to four-fifths of crypto trading on unregulated crypto exchanges may be fake, according to new research.

[…] most major unregulated crypto exchanges feature excessive washout trading, says the Crypto Wash Trading report, which was recently distributed by the National Bureau of Economic Research. It was written by , Ke Tang and Yang Tang, both of Tsinghua University, and Lin William Cong of Cornell and Xi Li who lives in Newcastle Upon Tyne. and 81.8% on Tier 2 exchanges. Tier 2 exchanges were mostly founded in 2017 and 2018, while Tier 1 exchanges were older, the report said.

Regulated exchanges Bitstamp, Coinbase, and Gemni must comply with government regulations. And the activity on these platforms is not in question.

But it seems that the unregulated trades cited by the NBER document are those where the washing trades can take hold. And for investors, that’s a big big deal.

Investopedia defines wash trading as follows:

Shadow trading is a process where a trader buys and sells a security for the express purpose of providing misleading information to the market. In some situations, wash trades are executed by a trader and broker who collude, and other times wash trades are executed by investors acting as both buyer and seller of the security.

This is important for several reasons. The first is that fictitious trades create the illusion that the market for the security or asset has larger trading volumes than actually exist.

The phrase volume-create-volume comes to mind here. When an asset’s trading volume takes off, institutional investors tend to become more interested in betting their money on that asset. However, these investors are likely making the decision to invest based on the belief that the indicated volume is extremely legitimate.

The NBER article cites data showing that 19% of institutional investors invest in crypto.

Fake volume creates a lie that can lure investors in the same way that fake profits shown on an income statement entice investors to part with their money.

This is at least part of the reason wash crafts are banned by US law. Additionally, Wash trading was used by investors in the past to avoid income tax and is also illegal.

Does this mean that these unregulated crypto trading platforms are doing something wrong?

Maybe. Maybe not, according to the NBER article. It states: We do not claim that all wash trading is done by exchanges. Individuals could also wash out the trade.

In other words, it remains to be seen exactly who should be singled out for the possible market manipulation described by the authors in the NBER article.

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