Q: Does cryptocurrency trading volume grow on trees? A: Yes.
A quick overview on the magnitude of exaggerated trading volume reported by cryptocurrency exchanges
The prevalence of exaggerated trading volume in the cryptocurrency ecosystem is far from a secret and ground level research shows that most of the cryptocurrency exchanges leading in volume rankings exhibit blatant and clear signs of artificially inflated trade statistics and volume figures, many times to levels as high as 4 to 10 times the multiple of the the real numbers, if not entirely fabricated.
For those new to the cryptocurrency space, it’s important to be aware of this phenomenon. Trading volume is the amount of securities or coins that were traded during a given period of time. In the context of a single stock or asset trading on an exchange, the volume is commonly reported as the number of shares or coins that changed hands during the day. A high volume should signal that assets or coins are popular and liquid, with many buyers an sellers ready to trade them for money and thus create liquidity.
Reported volume should not be considered a meaningful parameter on its own when looking at the cryptocurrency markets.
The magnitude of artificially created volume figures in cryptocurrency exchanges leads us to a conservative estimate that more than 80% of the volume reported today on indexes such as CoinMarketCap.com is ‘fake’.
Why is there so much fake volume?
Creating inflated volume can be both easy and profitable. Exchanges create artificial volume either in order to draw customers seeking liquidity, in order to gain attention through CoinMarketCap.com volume listings or in order to receive large fees from coin projects seeking liquidity for their coin who are willing to pay for listing their coin on an exchange, mistakenly thinking it is full of buyers and sellers.
Coin owners also have reasons to try and inflate volume figures: Higher trading volume draws traders to an asset, and can be a (false) signal to investors that it has a lively and healthy market worth investing in.
How is the volume faked?
Most cryptocurreny exchanges are not regulated and faking trading figures isn’t strictly illegal, perhaps that is why it is done in ways that are easily noticed — Hacken’s CER blog has exposed over the last year some of the biggest ratios of inflated volume in many cryptocurreny exchanges by observing clearly unnatural volume patterns, comparing site traffic and user numbers to reported trading volumes and comparing different exchanges, examining the exchanges social media and analyzing volume against known algorithms that detect unnatural behavior.
Taking a look at CER’s work easily paints the picture of the severity of unreliable figures on volume in this young market.
Four methods for artificially inflating volume:
- Most of the artificial trading is created by wash trading — buying and selling to yourself in order to increase the perceived trading activity, this practice is usually executed by an automated trading bot that is directed to trade with itself.
2. Another way to easily inflate trades and volume can be done only by an exchange: The trading information is public, but bogus trades need to be added to the public trade list somehow, so trades are added by executing them at a price that dose not exist in the market. For example, if the highest bidder in the exchange is offering 30$ for an asset and the cheapest sellers is asking for 31$, while the traders are waiting for a resolution, the exchange adds a new trade executed at 30.5$, the trade is smoothly added to the volume statistics without interfering with the real trading activity.
3. “Transaction-Fee Mining” is a new way to inflate trading volume figures. This exchange policy encourage the exchange costumers to wash trade for them- the exchange compensates traders with tokens according to the amount of trading they execute in the exchange and even run trading contests with the same objective.
4. The last method we have encountered is simply counting each trade twice. If for example 1 Bitcoins worth of Dogecoins were bought on the exchange, the exchange will count it both as a buy and as a sell, adding 2 BTC (bitcoin) to the volume figure.
We‘re quite confident there must be more creative methods for inflating volume figures out there! Please comment if you’ve have one to add to our list.
Poor liquidity
Knowing the real volume of trading is a useful signal for people wanting to sell (or buy) their coins in the marketplace. High trading volume should mean there will be enough buyers as well as sellers willing to exchange large quantities of an asset at a price that is close to the current market price.
In Chasing Fake Volume:A Crypto Plauge, a research piece posted last March, Sylvian Ribes examined the strength of the order books (the magnitude and density of buy and sell offers posted to the exchange) and compared crypocurrency exchanges with slimier reported volume.
Ribes checked how much a sale of 50,000$ or 20,000$ will impact the price of the most popular traded coins. In an exchange with good liquidity driven by many traders, you should expect the price will not drop significantly even with a large coins sale. Sylvian was shocked by some of his findings, discovering more evidence of volume fakery in some well known exchanges, and suspicious or disappointing liquidity in others: Many pairs, albeit boasting up to $5 million daily volumes, would cost more than 10% in slippage, should you want to liquidate a mere $50k in assets.
This research gets to the heart of the problem- inflated volume sends the wrong signals about the liquidity and depth of the markets, and severely inhibits intelligent and healthy trading activity.
When will it end?
Lately, many countries have started regulating more closely cryptocurrency exchanges, this is expected to lower significantly the amount of blatantly inflated volume creation in these exchanges, as it will become illegal, but due to the borderless nature of Bitcoin, the cryptocurrency world is inherently global and open, for bad and for good, and it’s reasonable to expect unregulated activity for many more years, as long as the exchanges platforms profit from trading fees.
The nature of future activity will mostly depend on the level of discourse and information in the ecosystem and the amount of amateur investors in the space who sadly get duped time after time by bogus and misleading information.
Today’s wash traders and unregulated exchanged who create fake volume aren’t trying very hard to hide it, it’s very blatant and easy to detect. Thankfully it seems that today the cryptocurrency space has a pressing need to improve credibility in the eyes of public, so there’s more motivation than ever to sound the alarm on suspicious activity and to educate and warn the public.
Discussions and awareness higher the bar for fakery, and if awareness of this situation keeps spreading, it’s expected the some companies who still are adamant on faking trading activity, will use more sophisticated methods and algorithms in order to hide it. That said- if there is true liquidity or not will always discovered at the end of the day, until then -may the buyer beware!
Future Development: Decentralized Exchanges
Another positive development will come as the unregulated trading activity is increasingly forced to pivot towards decentralized and distributed exchanges as customers who cannot or do not want to trade on regulated exchanges will be forced to use them. The higher the level of transparency and decentralization of these exchanges, the more regulation-proof they are.
The transparent and decentralized design of these exchanges takes away the information advantage today’s exchanges have over the costumers, and manipulation from inside the exchange mechanism is completely eliminated. Wash trading in a decentralized exchange is still possible but cannot be done without paying the exchange trading fees, which are significantly higher in high quality decentralized exchanges. If you’re interested, you’re welcome to read the previous posts on decentralized exchange technology and the current state of their ecosystem.
This information was published through the courtesy of Efficient Frontier
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For inquiries please e-mail chris@efrontier.io
