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The Detection Series: despite legislation, Wash Trades are still manipulating markets

Examples of Wash Trades Continue to Be Publicized

In 2014, Montgomery Street Research was charged with 100 counts of wash trading. Each buy-sell transaction occurred within a 90-second window, resulting in the Securities and Exchange Commission (SEC) bringing an enforcement action upon the firm. Of course, we’re all familiar with the LIBOR scandal. UBS traders pocketed £170,000 in fees from nine wash trades to manipulate the Japanese Yen.

Following a 2015 market manipulation by a South American subsidiary of Cargill, the U.S. Commodity Futures Trading Commission (CFTC) charged the sugar traders with market abuse. In addition to the wash trades, numerous other illegal, non-competitive transactions for several futures products were also identified. Aruba-based Copersucar Trading AVV, which is a subsidiary of the Brazil-based Copersucar SA, admitted to using wash trades in order to resolve account imbalances and was subsequently fined $300,000 following an investigation by the CFTC. Regulators detected identical buy and sell orders for sugar futures which were made by different brokers. All the transactions were recorded on an exchange managed by ICE which highlights how multiple loopholes still exist and be exploited.

A few years later, the CFTC issued a Guide to Energy Market Manipulation given the prevalence of wash trades and spoofing within that industry. Despite an extended multi-year investigation, limited direct evidence has been identified to correlate advanced technology with market abuse. Studies suggest that high-speed transactions conducted by high-frequency traders are enabled through the use of advanced technology. Here, natural language processing (NLP) and other approaches utilized for monitoring electronic communications can be designed to extract suspicious keywords to automatically trigger an alert for added vigilance around the transactions of those that need to be monitored more closely.

Cryptocurrency Is the New Wild, Wild West of Wash Trading

As is often the case for a new field or the application of new technology, there are always a few bad actors who exploit the initial lack of regulations and transparency. Cryptocurrency is still a nascent field but one that is coming under intense scrutiny for financial malpractice. Wash trades are commonplace, particularly on new exchanges that appear to be popping up almost daily. These new exchanges do not enforce disciplinary trading practices nor do they feature robust controls to impede market abuse.

Last year, Bithumb, a South Korean crypto exchange, was charged with wash trading $250,000,000 daily in fake volume. Another exchange, Bitfinex, was accused of wash trading and market manipulation but its “server malfunctions” were blamed and no charges were pressed. To get a glimpse of what 24h of wash trading looks like, have a look at this 2017 video which shows a day of trading on the Kraken crypto exchange.

Due to the global interest in e-currency, both cryptocurrency and bitcoin are actively being wash traded with startling frequency. The Blockchain Transparency Institute conducted a retrospective analysis of 2018 wash trades and found that 23 out of 25 exchanges had wash trades. Moreover, several of those exchanges had only ~10% of the reported 24h volume being real. An additional study of 131 exchanges revealed that 67% of the transactions were fake. Excluding the two major, reputable exchanges that were included in the study pushed the percent of fake transactions north of 80% and was estimated to be as high as 99%. On September 23, 2019, ICE offered Bitcoin futures trading. It will be interesting to observe how the frequency of wash trades on ICE compares to other exchanges.

How Wash Trades Can Be Stopped

Some proponents favor imposing stricter penalties, while others look to the exchanges themselves to uphold and enforce fiscal responsibility and ethical trading practices. However, many exchanges participate in trading games that catapult the price of a given token, only to send it plummeting once the “game” is over. Setting tiered fee schedules actually increases the potential for wash trading. As such, one solution would be single-fee schedules for all traders on the exchange.

As discussed, robust features that prevent self-trading should be a mandatory part of every exchange. However, this is not yet a global standard. Similarly, traders should be restricted to a single account to impede the potential for market abuse. Time stamps could also be better utilized.

Wash trades disrupt the marketplace as a result of the over-inflated perception of trade volume. Organizations that leverage the illegal practice ultimately discredit their industry and destabilize the market. Until increased legislation – with teeth – is enacted to enforce market transparency and protect against market abuse, there will continue to be wash trades and other questionable financial transactions.

Don’t take the risk. And don’t wait for a new bill to be proposed and enacted into law. Take action now with a complete solution for proactive surveillance, digital compliance, and investigation to reduce the risk of market abuse.


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