CoinMarketCap has become the default method of checking the crypto markets.
But staring you in the face as you open it up every morning is one of the biggest con tricks ever pulled.
It draws together the trading volume from hundreds of different exchanges. Some you will know. Binance, Kraken,
or Huobi. Some you may never have heard of.
What if the trading volume on some lesser exchanges wasn’t really there? What if it magically appeared in order to push prices higher, with no real buyers or sellers?
That’s Gavin Brown, a Senior Lecturer in Financial Economics at Manchester Metropolitan University and a Member of the Future Economies Research Centre led by Professor Donna Lee. He qualified as a chartered accountant and worked at
before starting his own hedge fund in 2008.
The larger exchanges, the Binances of this world, have a reputational incentive to keep things above board and to get it right, says Brown.
“The more liquidity an exchange appears to have, the more appealing it becomes to investors, this is simple buying psychology,” he argues.
To get real investors trading on their smaller platforms, why wouldn’t an exchange inflate volume to make their offering more attractive?
When there is more liquidity, there appears to be a better chance you can move in and out of positions quickly and so make money when you spot an opportunity.
The same kind of thing does happen in traditional stock markets, but they are much more heavily regulated and the penalties much greater if unscrupulous brokers are discovered.
In his previous role as an auditor for stockbrokers Brown developed a keen eye for spotting what was real and what was fake.
“If you are a large broker with, say, five to ten thousand clients, and you’re getting in orders for very popular stock like Shell, or British Airways, what you might do is to take a buy order for a client for a thousand shares, and take a sell order from a second client for a thousand shares, and swap them around, without ever placing those trades on the market.
“A client would never know it had been done internally through netting. The broker would get to charge commission without suffering any market transaction fees, even if they had only transacted 5% of what they had been told to buy and sell.
“By contrast, when you wash a trading book – what is commonly known as “wash trading” – you are fabricating trades. You are the counterparty on both sides of a trade.
“It looks like a legitimate trade but in reality you are both the buyer and the seller. There’s no commission charged and it doesn’t affect anything but the volume.”
How hard is wash trading to pull off? “It’s not very difficult,” says Brown.
“It’s easy for exchanges to put together a bot to add layers to their trading structure, so they don’t ever have to engage in these trades on a personal level.”
“If we all saw the true volume of what was being traded on exchanges, we would probably only see a tiny proportion of what is being reported,” Brown says.
A huge number of trades are already undertaken by algorithms. According to Crypto Fund Research, 17 algorithmic funds have entered the market in the last eight months and account for 40% of new cryptocurrency hedge funds.
Algorithmic trading is likely behind the latest BTC price surge back towards $5,000. Apart from a convincing and widely-shared April Fool’s story, there was no long-awaited news on ETFs that underpinned this sudden march of the bulls. A key technical indicator was surpassed at around $4,200 and it sparked a buying frenzy driven by bots.
Speaking to Reuters, analyst and CEO of London’s BCB Group Oliver von Landsberg-Sadie said a buy order of 20,000BTC spread across Coinbase, Kraken and Bitstamp likely shifted markets upwards.
He said: “There has been a single order that has been algorithmically-managed across these three venues…If you look at the volumes on each of those three exchanges – there were in-concert, synchronized, units of volume of around 7,000 BTC in an hour”.
Regulators roll out
So is it down to regulators to move faster to protect investors? Well, yes. But the lack of knowledge around cryptocurrencies is a significant barrier.
The achingly slow pace of piecemeal, country-level regulation is a real problem. So much so that the European Securities and Markets Authority specifically called for EU-wide regulation on cryptoassets at the start of 2019.
Even a decade after Bitcoin arrived it is still poorly understood among the general public.
Research by the UK financial regulator in March 2019 found only 27% of people in England could identify what a cryptocurrency was.
In the financial world, it’s not much better.
Gavin Brown again. “When I go and speak to the UK’s HMRC or the Bank of England, there’s a real gulf of understanding about what cryptocurrencies actually are.
“Cryptocurrencies are disrupting not just hundreds of years but millennia of banking practices.
“The characteristics of this technology are unique. And crucially, they simply do not fit into the existing regulatory system.”
Are they assets? Securities? Commodities? Even the smartest people at the world’s largest financial regulators can’t figure it out.
The Laundry Room
Wash trading is a truly significant problem in the crypto space. And the more research comes out, the more the estimated number of fake trades keeps going up. Wall Street Journal reporters investigated the issue in October 2018 and estimated 67% of volume was entirely illusory.
A couple of months later, a report by the
Transparency Institute found that up to 99% of trading on certain exchanges was clearly wash traded.
Researchers looked at CoinMarketCap’s top 25 BTC trading pairs, and saw that only three were “not grossly wash trading their volume”. For example, of Coinbene’s reported 24-hour volume of $222.8 million, the BTI could only verify $2.7 million.
Crypto wash trading is becoming a huge concern to the traditional financial system.
More big banks now have significant exposure to cryptocurrency as the market matures and it becomes just another alternative asset class. But vast numbers of fake trades inflating prices put the security of these banks at risk.
Overexposure to a largely unregulated market prone to faked volumes and price crashes could spell devastating trouble for economies across the globe.
The Financial Stability Board advises the world’s 20 leading economies. It is made up of central banks and market regulators. The
, the World Bank, the OECD and the Bank of International Settlements (often called the ‘bank of banks’) are all founding members. Its mission, as its name suggests, is to promote stable financial systems which can survive downturns, shocks, crises and recessions.
In a July 2018 report to the G20, the FSB chair Mark Carney, who also serves as the head of the Bank of England, highlighted that practices illegal in equity markets were rampant in crypto. These are wash trading, pump and dumps and spoofing – where traders (or as we now know, more likely trading bots) place buy or sell orders to shift markets in one direction or another, before pulling those orders.
A particularly notorious bot called ‘Spoofy’ appeared in 2017. It sits on the Bitcoin network, placing huge orders before pulling out just seconds later. This has an immediate effect on the price, as signals indicate that large orders are being placed, prompting traders to buy.
Now that cryptocurrency prices are heading upwards, interest from investors is reforming and the bots are rising.