The Four Facets of Wash Trading Explained

As far as financial markets are concerned, there will always be individuals and groups who seek ways to make money in slightly shadier ways. The concept known as wash trading is a great example in this regard. While it is the most obvious form of market manipulation, it is also a very common practice in this day and age. Even in the world of cryptocurrencies, it is not hard to detect wash trading activities.

The Inflated Trading Volume

One of the more obvious signs of wash trading is how a specific financial instrument’s trading volume will seemingly skyrocket out of nowhere. It is not unusual for an individual market to be in more demand than the day before, the when wash trading occurs, the volume will be off the charts compared to its previous statistics. In a lot of cases, those volume spikes will either be short-lived, or simply remain in place every single day without missing a beat.

In the cryptocurrency world, this type of behavior is easy to detect. Since coin-tracking sites monitor exchanges’ volume, it is not hard to see where most of the trading “activity” originates from. Over the years, there have been numerous allegations regarding potential wash trading efforts in the cryptocurrency world. Proving something nefarious is taking place, is always a rather complicated matter.

The upside for shady traders is how this type of inflated volume seems to indicate a financial instrument is in higher demand all of a sudden. As so many others watch for any signs to jump on the next “gravy train” in the financial sector, there will always be individuals who hop on the bandwagon accordingly. Those will also be the people who ultimately pay the price for this inflated trading volume, as they will be left holding a bag of a financial instrument which wasn’t necessarily in high demand in the first place.

Generating Commission Fees

While most people would automatically assume wash trading is something done by traders, that is not always part of the story. The platforms involved in this type of behavior are not always without blame either. In fact, there is a genuine chance the exchange or trading platform is using this behavior to generate commission fees to brokers. As unusual as that may sound, it is not something new under the sun either.

By going down this route, companies can “pay” brokers for doing something which would otherwise be deemed illegal. Albeit wash trading is officially illegal in a fair few countries, using this method of approach seems to remain under the radar without too many problems. Being able to pay market makers and takers for something that can’t be openly paid for is a very risky strategy, but it is a business model which can be explored for those willing to put everything on the line.

One interesting example of this approach comes in the form of the Libor scandal. For those unfamiliar with the concept, it revolves around fraudulent actions connected to the London Interbank Offered Rate, or Libor. During the scandals, banks were inflating or deflating interest rates to make them seem more creditworthy to onlookers. While this scheme was shut down eventually, it just goes to show no one won’t stoop to this level when there is a ton of money to be made. Greed often brings out the worst in people, for rather obvious reasons.

Is it an Illegal Activity?

For all intents and purposes, manipulating trading volumes and trading perception are a very gray matter at best. In the United States, it is illegal to commit to wash trading with regulated financial instruments, such as stocks. This rule has been in effect since the Commodity Exchange Act was first introduced in 1936. That doesn’t necessarily mean wash trading has not occurred since that time, but the ones who have been identified as culprits have faced severe penalties because of their illegal activity.

In the rest of the world, wash trading is also frowned upon, albeit the official guidelines are seemingly less clear on this front. Anyone outside of the US performing this illicit behavior through an American company or platform will have to contend with the US guidelines in this regard. It is somewhat safe to assume wash traders will not get away scot-free regardless of where they reside or trade, albeit such investigations can often take months, if not years to be completed successfully.

The Unregulated Cryptocurrencies

Not too many people will be surprised to learn this type of illicit trading behavior is somewhat common in the world of cryptocurrencies, tokens, and digital assets. As these instruments are not officially regulated in the majority of countries, there does not appear to be any recourse if wash trading occurs. This applies to both the traders themselves and the trading platforms (knowingly) facilitating this type of behavior.

Over the years, there have been a few interesting reports which claim there is plenty of wash trading going on in the world of cryptocurrency. Albeit those reports tend to send a shockwave throughout the industry as a whole, it would appear the activity itself is not necessarily relenting. Until cryptocurrencies are officially regulated, it seems plausible to assume this type of trading will continue to happen for quite some time to come. Whether the culprits will be punished for their actions in the end, remains a big mystery.

Disclaimer: This is not trading or investment advice. The above article is for entertainment and education purposes only. Please do your own research before purchasing or investing into any cryptocurrency.

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