What Are Wash Trades and Why Are They Dangerous?

In a recent interview, celebrity and cryptocurrency invest Mark Cuban warned individuals to be cautious of buying cryptocurrencies which have a large portion of wash trades. But what are wash trades? And is there any way to know which exchanges have a large portion of wash trades?

We’ve investigated and found the answer for you. Read on to learn all about wash trades and why they are dangerous for cryptocurrency.

What is a Wash Trade?

A wash trade is the purchase or sale of a specific cryptocurrency for the purpose of misleading other traders. Typically, in wash trades, it is a single entity on both sides of the trade. Or it can be a buyer and a trader who work in collusion with one another.  This is done to convince buyers that there is a high trading volume for a coin which really has no purpose.

For example, Individual A could have multiple wallets for a certain cryptocurrency, say Dogecoin, and they could be sending money from one wallet to another. This will show up on the ledger as multiple individuals trading Dogecoin when it is really someone just sending money back and forth to themselves.

Wash trading can also look like Individual A and Individual B, who are both Dogecoin investors, agreeing to send the same amount of money back and forth with one another in order to increase trading volume to convince others to buy into the coin. This will raise the price of the coin, allowing them to cash out at a profit.

Wash trading is illegal in the United States under the Commodity Exchange Act of 1936, but like with many other crimes, it can be hard to trace so people will execute wash trades anyway, especially in cryptocurrencies.

What is So Bad About Wash Trades?

Wash trades are dangerous because they mislead people into purchasing cryptocurrencies that aren’t truly popular and have very little use. One example in recent history where we think wash trading may have been a factor is the Dogecoin Saga.

Dogecoin rose to new heights is 2021 and crashed not long afterwards leaving many with less than their original investment. This rise and crash was referred to as a bubble, and it was caused by a couple factors. One of those factors was Elon Musk promoting the coin on his Twitter. But while he promoted the coin, the trade volume truly did increase. The problem is, we suspect many of these trades were wash trades, because there aren’t many places on this earth where you can spend Dogecoin. Plus, we don’t even really know of any companies who take Dogecoin as payment.

This means that all of the trading involved in the Dogecoin bubble was likely individuals sending money back and forth to themselves. Combine this with a celebrity enticing people to buy, and it’s easy to explain why Dogecoin rose in value. But just as quickly, the price came tumbling back down as those who perpetuated the wash trades cashed out at a profit with no regard to the others who had bought in.

The Dogecoin Saga is a single example of why wash trades are bad. No matter how you look at them, they cause hype for a coin where hype shouldn’t be. This is dangerous for uninformed investors and is the exact reason wash trading was made illegal almost 100 years ago.

How to Spot Wash Trading

Unfortunately, it is very difficult to spot wash trading. But there are a few tell-tale signs you can look for which may indicate that a coin is being wash traded. If you spot any of these signs in a coin you are looking to invest in, don’t invest and instead run the other direction.

1. Look for Sites Which Use/Accept the Coin

In theory, all cryptocurrencies have a purpose, but many are scams. These scams will often tell people they have use, but in reality, you are just buying a name. To weed out these scams, look for locations which accept or use the cryptocurrency you are buying.

For example, there are many companies like Amazon and Overstock which accept Bitcoin. This means it is feasible that people would spend their Bitcoin to buy these products. But if you are looking for the utility of, say, Shiba Inu, you will have a hard time finding a website that accepts these tokens. That means that the trading volume of Shiba Inu can’t be attributed to purchases and instead may be the cause of wash trades.

2. Look Where the Coins Are Being Traded

In the cryptocurrency world, there are a few large exchanges which handle most of the legitimate cryptocurrency trades. They are Coinbase, Binance, Kraken, and KuCoin. If you see that the cryptocurrency you are wanting to purchase has a lot of volume on a single exchange or only on less regulated exchanges, such as EXMO, this could be a sign that the trades being perpetuated are wash trades.

Remember, a cryptocurrency that truly has volume in trades will have volume across several different exchanges. This shows that the trading volume is more organic as most wash traders don’t have accounts on all trading platforms. That being said, it is possible to have accounts on 2 or 3 platforms that someone uses for wash trading. This is why it is important to take all trading platforms into account and not base your decision on the volume of trading a certain coin on a single or select few platforms.

3. Look at When the Coins are Traded

A coin with true trading volume (i.e., Bitcoin) will be traded around the clock every day of the year. If you investigate a cryptocurrency and see that it had a small window of increased trading followed by days of nothing, this is a sign that someone, or two someones were wash trading for a period just to try to increase volume.

 

In the end, it will be your job to decide whether a cryptocurrency you wish to buy is being subject to wash trading, or genuinely experiences a large trading volume. In general, the only way to avoid purchasing a cryptocurrency which isn’t wash traded is by not buying one at all. But you can lower your risk by only purchasing the coins which have proven uses, and trading volume such as Bitcoin and Ethereum.