Opinion: Bitwise’s 95% fake volume report is good for Bitcoin
The real volume among the wash trading shows a healthy market that exemplifies the benefits of BTC.
- The 95% figure is a ballpark amount.
- It's easy to separate fake from legitimate volume, and when you do you can see the real state of the market.
- Bitcoin's transparency makes it easier to identify wash trading, and lends it to fairer and more purely market-driven price discovery, than in traditional assets.
In a 20 March report to the SEC, Bitwise presented findings to the US Securities and Exchange Commission (SEC), as it pondered the future of Bitcoin exchange traded funds (ETFs). The report was part of Bitwise's Bitcoin ETF application. The most striking and widely reported takeaway was that it estimates about 95% of the commonly-reported cryptocurrency trading volume to be fake.
On one hand, these outrageous findings sound like they should be a deathblow for any asset that's struggling for even a breath of legitimacy, let alone SEC approval for an ETF.
On the other hand, it means "the real market for bitcoin is significantly smaller, more orderly, and more regulated than is commonly understood," as Bitwise said.
95% fake
It's worth noting that the 95% figure is not gospel. The exact amount would change frequently, and as the report shows many exchanges suspected of faking volume will often periodically switch their volume on and off, so the exact proportion of the market that's fake volume will change constantly.
One exchange might up the fake volume for certain coins because a client has purchased the "volume booster" package, while another might raise it to try to attract new users during what they perceive to be a bullish time, or to hype up a new coin, or because they're about to try asking for an excessive listing fee.
At the same time, various technical issues will periodically lead to misreporting, while the biggest trades take place over the counter and off the exchanges, and so don't show up on the charts.
It's also worth emphasising that the "95% fake" estimate refers to Bitcoin only, whose fake volume will likely trend higher than the overall market average given its popularity as a pair for other coins. Basically, if an exchange wants to start wash trading some random cryptocurrency, perhaps because its developers have purchased a "volume booster" package, most of that wash trading will probably be against Bitcoin.
Adding to the variation in wash trading, is the fact that many of the suspected fakers exercise hilariously little restraint. For example, at the time of writing the world's number one exchange by self-reported volume, according to CoinMarketCap, is reporting a fairly unlikely US$5.3 billion in 24 hour trade volume. That's about a solid 15% of the $30 billion 24 hour trade volume of the cryptocurrency markets as a whole, as per CoinMarketCap's reckoning.
If that one exchange were to suddenly switch off, that 95% estimate could swing downwards by a couple of digits. And if another couple were to turn on similarly egregious displays, you could rightly estimate that closer to 99% of Bitcoin trading volume is fake.
This is not to downplay the findings, and it's clear beyond any doubt that wash trading is rampant in cryptocurrency. Rather, it's just a reminder that the 95% figure is a rough and constantly changing ballpark, and that the volume in the cryptocurrency markets as a whole could skew the slightly more real side of things than Bitcoin by itself.
The important part is that it's not especially difficult to weed out the vast majority of the fake volume, and that when you do a much clearer picture of the legitimate market emerges. And it's a fairly happy picture.
Healthy indicators
When you look at Bitcoin as an equivalent to gold, the asset looks much healthier once you cut out the fake trade volume, Bitwise says. Indeed, it would be fairly terrifying if all the reported volume was actual volume because it would imply that 8.6% of all Bitcoin was changing hands every day.
If you assume the Bitcoin markets are 95% fake, Bitwise estimates the daily gold turnover to be 0.55% of the circulating supply, and the daily Bitcoin turnover to be 0.39% of the circulating supply. Without the fake volume, Bitcoin trading appears much more rational and much more in line with other assets.
At the same time, all this fakery means it's possible to narrow down the legitimate market to a relatively small bundle of key players.
Bitwise did this by stripping out all the obvious fakes and removing Korea-based exchanges on account of their regular price disparities. This left it with a list of just 10 significant, legitimate exchanges which together account for almost all legitimate Bitcoin trade volume:
When you look at those ten exchanges alone as representative of the entire crypto market, which they arguably are, the appearance of an unregulated wild west drops away, and you're left with a much clearer picture of where the trading is and which authorities are responsible for overseeing the marketplace participants.
Bitwise report, page 64.
The price disparities between exchanges also tend to disappear and all the top ten exchanges trade Bitcoin within 0.25% of each other's price, once you adjust for various fees, volatility and hedging costs.
This also goes to one of the hearts of what the SEC is looking for in an ETF.
Price discovery
One of the main issues with wash trading, in the context of approving or denying a Bitcoin ETF application, is not that wash trading gives bad vibes or that Bitcoin is too small to deserve an ETF. It's that the ETF needs a sensible way of tracking Bitcoin prices, and that the proposal needs to justify its proposed method of price tracking.
The Bitwise report cites the Gemini Bitcoin ETF application, which argued that its Bitcoin ETF should track the prices at Gemini. This was turned down due to concerns that Gemini's price was not a suitable proxy for overall Bitcoin prices as a whole.
In the words of the SEC: "The issue here is not that the Gemini exchange has low trading volume in the absolute sense, but rather, that the Trust would value its holdings using the Gemini auction price, even though there is no basis in the record to find that the Gemini Auction represents a significant portion of the worldwide Bitcoin trading."
The Bitwise ETF proposal aims to overcome this issue by drawing its prices from those top ten exchanges, for an indicator that it hopes is suitably diverse, manipulation-resistant and representative of actual Bitcoin value to satisfy the SEC.
The Bitwise ETF proposal also argues that Bitcoin is uniquely resistant to manipulation, due to its transparency, functionality as a purely digital asset and fungibility.
The fungibility is debatable though. Some would argue that Bitcoin's transparent ledger means it's not actually fungible, and that a "fresh" Bitcoin without a history is worth more than a used Bitcoin.
But either way, as an almost instantly-transferable asset it can be moved quickly if arbitrage opportunities or disparities arise, Bitwise points out. This has also turned the legitimate Bitcoin market into a widely distributed tamper-proof marketplace, with no one exchange commanding a majority share of Bitcoin volumes.
A market consisting of 95% fake volume is good for Bitcoin
It's probably a stretch to say that rampant wash trading is good for Bitcoin. But it's not a stretch to say that the impact is much less significant than the "95%" number would suggest, and that the fakery is mostly for the purpose of unscrupulously scraping up some personal profits from coin listings and unwary users, rather than impacting the wider markets.
The reason it's good for Bitcoin is because it's very possible to weed out the biggest offenders, and once you peel away the wash trading there's still a healthy Bitcoin marketplace at the centre of things, which exemplifies many of the qualities that make Bitcoin genuinely different from other assets.
As Bitwise pointed out in its report, the biggest market manipulation scandals in history have all been the result of deliberate and coordinated price fixing. For example, that time someone at Barclay's manipulated the setting of gold prices to enrich themselves at the expense of a customer. The only reason we even know about that particular scandal is probably because the bank was under a microscope having been fined for involvement in the Libor scandal of 2012 just the day before.
The Libor scandal was that time international banks systematically colluded to manipulate the Libor, which underpins some $350 trillion in derivatives and should ideally be a bit more shenanigan-resistant than this:
Pls go for 5.36 libor again, very important that the setting comes as high as possible ... thanks." - Barclay's Bank trader to rate submitter.
Of course, Bitcoin markets aren't entirely immune to all price manipulation. But the transparency and immutability of the ledger and marketplace means it's much more resistant to the most tricky, common and odious forms of market manipulation than other assets are.
Dismissing Bitcoin, just because 95% of its apparent trade volume comes from shady exchanges with poor impulse control, would be throwing out the baby with the bathwater.
Disclosure: The author holds ETH at the time of writing.
We've trimmed some parts of this article for speed. See the full version.
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