What is Crypto Wash Trading and How Does it Work?

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Wash trading is a form of market manipulation that can apply to both crypto and traditional trading stocks and shares on exchanges.

It can take many forms, but usually involves traders, brokers or investors colluding to fake trades to coerce the market price of a crypto or stock.

Exchanges have also been known to falsify trades to manipulate the value of an asset in order to profit from it.

Here, wash trading involves high volume trades that effectively cancel (wash) each other out almost immediately.

In effect these are fake transactions designed to create the impression that a much higher volume of trades are being made.

Wash trading and ‘pump and dump’ schemes

Wash trading is also associated with ‘pump and dump’ schemes, where the owner of a little known crypto artificially increases the price so they can sell high before it crashes.

An example of wash trading:
Trader A places a sell order for 1 Scamcoin. They then put their buying hat on and place a buy order for the same amount of digital currency.

The orders cancel each other out, or wash the transaction, but the damage is already done as the trading volume for said crypto has been artificially inflated.

Do this enough using high frequency trading bots and the price will pump artificially opening the door for the wash trader to profit from the manipulation.

According to some commentators, exchanges sometimes participate in wash trading in order to encourage new crypto projects to want to get listed while the exchange benefits from the hefty fees involved.

A 2021 research paper produced by Arash Aloosh and Jiasun Li from NEOMA Business School and George Mason University, found that up to 33% of transactions on some of the major crypto exchanges are wash trades.

The researchers drew upon data leaked by hackers who were probing market manipulation and wash trading.

They found “direct evidence” of fake volume allegations made by the hackers against certain cryptocurrency exchanges.

Using wash trading to reduce a tax bill

Wash trading can also be used by crypto investors to artificially reduce their tax liability by artificially creating a tax loss without actually losing anything.

Wash trading in traditional, regulated exchanges (stock and shares) is illegal, but at present the law doesn’t cover crypto exchanges meaning it’s a free for all for market manipulators.

It’s one of the reasons that the US Securities and Exchange Commission (SEC) refused an application for a spot Bitcoin Exchange-Traded Fund (ETF) created by VanEck Bitcoin Trust.

According to the SEC, the Cboe BZX Exchange, which made the application to list the ETF, had not proved that the product was designed to prevent fraud and manipulation, or that it would protect investors.

The possible sources of fraud cited by the SEC include:

• Wash trading
• Market manipulation by so-called ‘Whales’, ie those who hold a large amount of Bitcoin
• Hacking or malicious control of the Bitcoin network
• Trading on insider information or manufactured fake news

Spot Bitcoin ETF applications

At the time of writing there were multiple applications for a spot Bitcoin ETF in the pipeline, although SEC chairman Gary Gensler has made no secret of the fact that it opposes the product.

However, just weeks earlier a futures Bitcoin ETF (effectively based on price predictions) was agreed by the SEC causing a spike in the price of Bitcoin.