Cryptocurrency’s fake volume problems are on full display right now
Wash trading, fractional reserve exchanges and the selling of coins that don't exist are all common.
- Fake volumes take different forms in cryptocurrency. All are quite blatant, and have been unusually prominent this last week.
- There are reasons for exchanges to fake trade volumes, but they all tend to come down to money.
- There are several different ways for the cryptocurrency world to evolve past blatant wash trading.
A lot of exchanges started trading Grin right about the time it launched. Unfortunately, they started trading it before it was even minted, and after it was minted, they kept trading it in larger volumes than were in existence.
At around the same time, an exchange called ZB.com briefly became the world's highest-volume crypto exchange, according to the self-reported trading volumes on CoinMarketCap, after its volumes suddenly increased by a few hundred million dollars. Not to be outdone, another exchange called Lbank (which also has a history of selling coins before they've even been minted) decided to magically find a few hundred million of its own.
Meanwhile, two leaders of South Korea's Komid cryptocurrency exchange were just sentenced to three years in prison for faking trade volumes. They've reportedly admitted to creating 5 million fake accounts to wash trade 50 billion won (US$44.5 million) of cryptocurrency.
South Korea's other exchanges are also in the spotlight.
The country's Financial Services Commission (FSC) has accused UPbit of perpetrating the equivalent of US$226 billion in fake trades. Bithumb has been subject to similar allegations, and while it hasn't been formally slammed the way UPbit and Komid have, it looks like it might be heading the same way based on the strength of the statistical evidence arrayed against it. The Blockchain Transparency Institute (BTI) reckons that many of the top trading pairs are about 99% fake volume.
In each case, a different reason is given for the fake volumes, and all of them boil down to real money.
The BTI suggests that one of the main drivers is for exchanges to charge inflated listing fees to cryptocurrency projects. While South Korea's authorities have alleged that UPbit and Korbit are faking volume purely for the purposes of drumming up hype and pulling more people into cryptocurrency.
South Korea is undeniably big on cryptocurrency, but it's probably more for the downtrodden commoners than anyone who can afford a place on Seoul's property ladder. The big numbers on exchanges suggest big money, but there's no guarantee it's actually there.
The shenanigans around Grin might be a bit more straightforward. You just sell something that doesn't exist and pocket the profits plus trading fees. It all works out as long as you don't get a bank run – and sufficiently expensive and slow withdrawal procedures can help with that. Based on the fakery around the markets, it seems quite likely that many exchanges are running a fractional reserve of sorts.
It's almost certainly happening with bitcoin and other top cryptocurrencies too, and it's safe to say there's more bitcoin on paper than there is in actual circulation. There are zero guarantees of anything that goes on behind the doors of a centralised exchange or that the crypto you think you're buying even exists.
The bear markets of 2018 filtered a lot of fraudsters out of cryptocurrency, but the blatant wash trading continues. It's a problem that will likely have to be solved for the cryptocurrency space to make more serious inroads.
What can be done?
A good starting point by any measure is to not patronise illegitimate exchanges and for authorities to crack down on wash trading where possible. It's nice to see arrests and investigations happening in South Korea.
Exchanges in the USA, Australia, the UK and Europe tend to be much, much cleaner than the global average according to BTI findings, and beyond that Binance, Bitfinex and Liquid have been assessed as having 100% legitimate volume. It might be worth being careful about the so-called "Chinese rip-off armada" of obviously shady exchanges like Lbank and the plain weirdness of some exchanges based in Russia.
In the longer run though, decentralised exchanges might be the saving grace of the ecosystem. The more shadiness there is on centralised exchanges, the more likely it seems that they're going to play an increasingly important role in the future of cryptocurrency.
It's also worth noting that one of the reasons wash trading appears so common in cryptocurrency is that blockchain technology provides a lot of information that you don't get from other assets, which makes it much easier to spot things like people trading coins that can't possible exist.
In this context, blockchain can similarly present an opportunity for cleaning up traditional markets. Wash trading is not a purely cryptocurrency phenomenon, and there are many reasons to believe it's rampant in traditional financial markets too. Imbuing other assets with the kind of transparency that cryptocurrency enjoys would likely be both revealing and depressing.
But first things first... cryptocurrency seriously needs to do something about its fake volume problem. It would be nice to see industry groups and legitimate exchanges take a more proactive role in working with authorities to take down the scammier exchanges where possible.
Disclosure: At the time of writing, the author holds ETH.