Fake it until you make it is a popular strategy among tech entrepreneurs. Application and software developers often brag about “tens of thousands” of users on their platform without independent verification from third parties.
Within the cryptocurrency ecosystem, faking has taken on the form of trading volumes. Cryptocurrency exchanges regularly report trading volumes that run into millions of dollars on a daily basis as proof of popularity of cryptocurrency trading among retail investors. The idea is to create an illusion of profits aplenty for traders.
But that tidy narrative is increasingly proving to be false.
Earlier this year, a report by asset management firm Bitwise estimated that approximately between 80% to 90% of all trading volumes at crypto exchanges were faked. The report garnered the attention of media and regulators, who latched onto it to delay a decision on approving a Bitcoin ETF.
Alameda Research, a crypto trading firm based in Berkeley and Hong Kong, recently produced a report and has set up a website to analyze fake trading volumes in real time. The site evaluates sixty exchanges across the world on a broad set of criteria to produce a “more accurate” picture of fake trading volumes as compared to Bitwise’s attempt. As of this writing, the website reports that the percentage of fake trading volumes across exchanges is 73.8%.
How to Fake Volumes
The firm evaluated cryptocurrency exchanges on the basis of six criteria to determine whether their reported volumes were actual or fake. According to them, their methodology provides a “more accurate” picture of fake trading volumes as compared to Bitwise’s report earlier this year. The criteria ranged from a manual investigation of trading history for fake orders to comparing the hourly volume of unregulated exchanges with the same figure for regulated exchanges to comparing order book depth with reported volumes and the volume of their own trading. The results, not surprisingly, displayed several instances of widespread misinformation in reporting.
For example, they found that many exchanges display absent trades that have not occurred at prices that are mostly an average of those for their exchange. In some cases, crypto exchanges also copy or duplicate order book data from another exchange. Some exchanges also report large trades during spikes of activity for a coin by buyers who are absent. The researchers found multiple examples of wash trading, or a trade in which the exchange itself takes an opposing bet to your trade, at cryptocurrency exchanges. Fake orders with purchase and sale prices lower or higher than existing quoted prices were also rampant. A Forbes article on the study provides examples of such orders.
Should Retail Investors Trust Cryptocurrency Exchanges?
The answer to that question is a complicated one. The problem of fake trading volumes is not limited to cryptocurrency exchanges. Previous studies have found that even mainstream and large exchanges, such as NYSE and Nasdaq, are not immune to them. Several news reports and studies over the years have chronicled the effect of fake orders, in which investment firms cancel orders before they are executed to create an illusion of liquidity for a given stock, on the markets. That said, the extent of fake trading volumes on cryptocurrency exchanges is far higher as compared to those at mainstream exchanges. The absence of regulation and checks to ensure trade integrity further compounds the problem.
As the cryptocurrency ecosystem evolves, metrics will be developed to make it possible to evaluate exchanges. Alameda’s research already provides some indicators for direction. US-based regulated cryptocurrency exchanges, such as Coinbase, tended to score higher on most of their criteria. Asian exchanges, which dominate cryptocurrency trading, are a mixed bag. Some like China’s OKEx have taken steps to clean up their act. Malta-based Binance and Hong Kong’s Bitfinex also score high in Alameda’s list of criteria. But scales tip the other way in cases like that of Bithumb, arguably Korea’s biggest exchange, which scores poorly on most measures. That said, the lack of sufficient liquidity means that cryptocurrency exchanges are susceptible to manipulation and frauds. Bitcoin whales, which are reported to swing market momentum through control of large stashes of the cryptocurrency, play a pivotal role. Trading statistics and volumes at exchanges will continue to be inconsistent and volatile.