Wash Sells Severely Inflate Unregulated Crypto Exchange Trading Volume

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The vast majority of crypto transactions on unregulated exchanges are essentially fake, giving the false impression of a much higher volume of transactions.

A recent study presented by the National Bureau of Economic Research estimated, in fact, that on average 77% of these transactions are essentially sham transactions, with investors simultaneously selling and buying the same financial assets to create artificial activity in the market. , which is known to distort price, volume and volatility, and reduce investor confidence and participation in financial markets. Sometimes it reaches 80%, depending on the exchange.

To find out, the researchers looked at cryptocurrency transaction information on 29 major exchanges, using a proprietary database run by TokenInsight, a data provider that offers advisory reports, evaluation and research for cryptocurrency related businesses.

The final sample contained 448,475,535 transactions. The study only looked at Bitcoin (BTC), Ether (ETH), Ripple (XRP), and Litecoin (LTC), which account for over 60% of cryptocurrency volume and are available on nearly every exchange.

Next, the researchers looked at the distribution of the first significant digit of transactions on each exchange against Benford’s law. Next, they exploited a classic behavioral regularity in trading: the clustering at transaction sizes of round numbers of cognitive benchmarks in individuals’ decision-making. Finally, they explored whether the observed trade size distributions had fat tails characterized by the power law as seen in traditional financial markets and other economic settings.

“These estimates translate to more than $4.5 trillion in fictitious trades in spot markets and more than $1.5 trillion in derivatives markets in the first quarter of 2020 alone,” the newspaper said. .

This serves to make the exchanges much more active than they actually are. For example, one of the unregulated exchanges has an average volume of $50,944 million; in contrast, a regulated exchange in the sample had a volume of $15,212 million. However, although unregulated exchanges tend to have higher trading volumes, the researchers said there can still be significant variations, pointing to an unregulated exchange that only has a volume of tens of million dollars, compared to a large number of similar exchanges. that process tens of billions.

The paper states that one of the effects, however, of unregulated exchanges tending to show higher volumes is that people become more likely to choose that exchange, at least based on web rankings.

“We find that regulated exchanges … lag behind many unregulated Tier 1 exchanges in their rankings based on web traffic. … Although trading volume rankings cannot fully represent quality and liquidity exchanges, it is used by most ranking agencies, so cryptocurrency investors are likely to choose an exchange based on these rankings based on trading volume,” the newspaper said.

However, not all crypto exchanges have proven to have such a rampant washout trade. The study indicated that it was virtually absent from regulated exchanges (which makes sense, as the practice has been illegal since 1936). Additionally, in the world of unregulated exchanges, the longer the entity has been around and the larger its user base, the fewer fictitious trades there are; conversely, the less established the exchange, the more likely washout exchanges will occur, with the paper claiming that there are powerful market incentives to allow this.

“One would expect that unregulated exchanges, especially later-launched ones, would be motivated to engage in shadow trading in order to gain higher rankings and acquire more customers,” the newspaper said.

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