How wash trading inflates crypto exchange volume, and how researchers detect it

A wash trade is a transaction, or pair of transactions, that makes it look like a buyer and seller exchanged an asset when in fact no one took on real market risk or changed their position. On a crypto exchange, doing this repeatedly inflates the volume figure the exchange reports, because the exchange’s volume counter adds up every matched trade regardless of who is on the other side. The legal definition The U.S. Commodity Futures Trading Commission defines wash trading in its glossary as “entering into, or purporting to enter into, transactions to give the appearance that purchases and sales have been made, without incurring market risk or changing the trader’s market position,” and the Commodity Exchange Act prohibits it, according to the CFTC. CME Group, which operates regulated derivatives markets, describes a wash trade under its own Rule 534 as a transaction or series of transactions that give the appearance of authentic buying and selling but are entered without any intent to take a genuine market position, per CME Group’s education materials. Neither definition is specific to crypto; both come from traditional derivatives regulation and are the standard researchers apply when they go looking for the pattern on crypto exchanges. The mechanism: how a wash trade creates volume out of nothing The simplest version is a self-trade: one account places both the buy order and the matching sell order, so it is trading with itself. Another version, which Friedhelm Victor and Andrea Marie Weintraud of Technische Universität Berlin describe as predominant alongside self-trades, involves two accounts controlled by the same person or working in coordination, passing an asset back and forth. Because account creation on a blockchain is essentially free and requires no identity check, running several wallets that trade with each other costs little, the researchers note in their paper presented at the Web Conference 2021 and posted to arXiv on 13 February 2021. Each pass adds to the exchange’s cumulative volume figure even though the trader’s net holdings never move. On a decentralized exchange, every trade and every wallet address is recorded on the public ledger, so Victor and Weintraud could reconstruct the actual account graph: which wallets traded with which, how often, and in what structures. Applying that method to two early Ethereum order-book exchanges, IDEX and EtherDelta, they identified a lower bound of 159 million U.S. dollars in wash-traded volume across the two platforms, according to their paper. They found that on both exchanges, more than 30% of all traded tokens had been subject to wash trading activity, and that on EtherDelta specifically, 10% of tokens had been almost exclusively wash traded.