Wash trading has slowly become one of the most deceptive tactics in the cryptocurrency and NFT markets, creating artificial hype and misleading investors. What once plagued traditional finance has entered the digital asset world, where manipulators use automated bots or wallet swapping to inflate prices and volumes. This strategy can make a particular project or a specific coin look like they are more valuable than its actual worth to unsuspecting buyers. It is even more crucial to know how crypto wash trading functions and how to identify it, especially given its popularity in crypto and NFTs.
What is Crypto Wash Trading?
Wash trading has been around for a long time and was frequently used in traditional markets to manipulate prices by creating the illusion of market activity. Nowadays, investors, traders, and less regulated exchanges have started using the same tactics (market manipulation) in the crypto world. They drive the price of cryptocurrencies by artificially inflating their trading volume. Normally, they send crypto from one of their wallet addresses to another, and this process is repeated by traders often, creating the illusion that the coin is in high demand. For unsuspecting investors, the trading volume represents buying and selling, and a large trading volume means traders’ activity is high. When a large number of traders believe that the coin is a good investment and buy the coins, the manipulators behind the scenes sell their coins and earn large amounts of profits through artificial hype.
One of the key purposes of employing wash trading regarding cryptocurrencies is to increase the attractiveness of a new project to investors. This method would make the token seem very sought after, hence attracting the attention of the traders involved.
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What is NFT Wash Trading?
Similar to crypto wash trading, NFT wash trading involves traders trying to hype the value of an NFT project by artificially inflating the price. Different from cryptocurrencies, where traders use trading volume to determine whether the coin is worth investing, NFTs are unique digital collectibles with a unique address on the blockchain. Unlike trading volume, NFTs have something called the floor price, which denotes the lowest market price. They try to boost the floor price by swapping the NFT multiple times between different wallets, which are controlled by the same person or a group of collaborators. This particular strategy of buying and selling at higher prices not only increases the floor price of the NFT but also deceives investors into believing that the NFT is being ‘offered’ at that price. Once these traders start purchasing the NFT at these inflated prices, the manipulators sell out their stocks, and the buyers end up with an expensive NFT that may not hold its value in the foreseeable future.
How Does Wash Trading Work in Crypto?
Wash trading has a huge impact on the normal functioning of crypto. Manipulators use various methods on unsuspecting traders, creating an assumption that the coin is legit and popular. Here are some of the methods that crypto wash traders usually employ,
- Automated Trading Bots: Wash traders use automated trading bots to execute buy and sell trades rapidly between controlled accounts. The rapid and large number of transactions implies that many traders are actively trading the coin, making unsuspected traders believe the inflated price is the real value of the coin and is worth the investment.
- Unregulated Exchanges: They look for exchanges that are not well-regulated, meaning exchanges lack advanced monitoring tools or less oversight. These types of exchanges make it easy for them to manipulate the market.
- Collusion Between Traders: Wash traders collude with each other by buying and selling the same cryptocurrency through several of their wallets, which ultimately creates the illusion of high trading volume.
How Does it Affect The Cryptocurrency Market?
- Misleading Trading Volume: Because wash traders artificially increase trading volume, it is difficult to find the exact market activity of the coin. Furthermore, this false data affects the trader’s research results, leading to a wrong conclusion about the coin.
- Price Manipulation: Due to the continuous and rapid buying and selling of the coins (high trading volume), the price of the coins will be affected and will rise proportionally. Once the prices are high, they try to lure unsuspecting crypto traders into buying the coin.
- Undermines Market Credibility and Transparency: The mass adoption of digital assets (crypto) is unlikely, and one of the main reasons is wash trading. Wash trading spoils crypto’s credibility by manipulating its prices. Until the crypto exchanges can solve this issue and make the trading data reliable, there is little hope.
How to Identify & Avoid Wash Trading in Crypto?
Crypto wash traders usually operate in the dark, but there are methods to identify and avoid them. They are,
- Check for Unusual Trading Volume: One of the main methods to discover wash trading is a sudden increase in trading volume. If you discover that a coin’s trading volume is increasing rapidly compared to previous days without any major event affecting the market or coin, there is a possibility of wash trading.
- Check for Unusual Trading Activity: Most of the time, they use automatic trading bots to place thousands of orders within seconds between the different addresses. If you notice large amounts of transactions between the same addresses by the same investor or a group of investors, it could be wash trading.
- Check for Trading Volume Across Exchanges: Compare the trading volume between different exchanges, and if you notice a huge difference in volume between the platforms, it could point towards wash trading.
- Check for Unusual Price Movements: Wash trading artificially raises the prices of an asset. So, check for any inconsistencies behind the price increase, and if so, wash trading is a possibility.
- Stay Informed: Do your own research before investing in the coin and check for any news related to the coin. If you find any inconsistencies behind a coin’s price increase and suspect price manipulation through wash trading, it would be best to avoid investing in that asset.
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Is Crypto Wash Trading Illegal?
Crypto wash trading is illegal because it distorts the price of coins by manipulating the market (trading volume). The Commodity Futures Trading Commission (CFTC) has reacted quite intensely to wash trading and penalized exchanges that engage in it. In addition, crypto exchanges have adopted some measures, such as data analytics and KYC, to eliminate wash trading in their platforms.
Conclusion
Wash trading is a major threat to the credibility and transparency of both crypto and NFT markets. Although wash trading has been around for ages, its entry into the digital asset market has brought new challenges because of the decentralized and less regulated environment prevailing in the market. They employ sophisticated methods like automated bots to create an environment where the coin price inflates because of the constant buying and selling of coins and lure unsuspecting investors into buying the coin. By staying vigilant and conducting thorough research, traders can better protect themselves from falling victim to price manipulation and false market data.
