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What Is Wash Trading? Wash trading has been present on traditional markets for decades, and refers to the act of buying and selling a security with the express goal of feeding misleading information to the market. This was made illegal in the U.
On a smaller scale, wash trading has also been used as a way to claim tax deductions from the government, as investment losses are generally tax deductible. The IRS has limited this activity by prohibiting taxpayers from deducting losses on a sale, if the investor repurchases the same asset 30 days before or after the sale.
With regulations and laws making wash trading extremely hard to do on traditional markets, it found its way to the crypto sector, where it is used to artificially inflate the trading volume of exchanges and crypto assets. Wash Trading In Cryptocurrency With the ever-increasing popularity of cryptocurrencies, more and more exchanges, and new crypto firms, have started to emerge on the market, all trying to attract as many users as possible to their platforms.
One way companies and exchanges try to lure users in is through high trading volume and liquidity. While there is nothing inherently wrong with that, firms often assign large scale traders to wash trade their assets. This operation can be automated with bots, making this back-and-forth trade extremely quick, allowing companies to easily fake the interest in a particular asset.
No mater which the correct number is, wash trading is a major issue for the crypto space, and its growth. Solution While the numbers shown above might be discouraging, the cryptocurrency community has already started to act. Wash trading is a relatively serious issue in the NFT industry. Not only does it serve to inflate prices for particular assets, it also makes the market a lot more popular than it actually is. Several studies have shown that there are a lot of non-fungible tokens that get traded 25 and more times between just a handful of wallets.
An example of a wash trade. NFT wash trading works the same way regular wash trading does. A trader sets up several or a lot of crypto wallets and uses them to buy and sell the same non-fungible token over and over again. Since the NFT market is mostly driven by user interest and hype, this works really well to drive up the values of all those assets. Not only does it increase the price of a particular NFT, it also drives up the liquidity and capitalization of the entire market.
It creates artificial hype that is eventually used to attract new market participants. First, they purchase a newly minted non-fungible token on a marketplace. Then, they buy it from themselves for ten times the price. In the end, Investor A takes a screenshot of their profit and posts it on social media. Of course, they end up losing money instead.
While wash trading is a type of market manipulation, it is not necessarily fraud because wash trades are typically executed between two or one willing participants. Both parties know that the trade is taking place solely for the purpose of artificially inflating the price. However, if one party is unaware that it is a wash sale, then it could be considered fraud.
Penalties for Wash Trading The penalties for wash trading vary depending on the jurisdiction. In the United States, wash trading is considered a form of securities fraud and can be punishable by up to 20 years in prison. In other jurisdictions, penalties may be less severe, but wash trading is still typically considered a serious offense. How to Avoid Wash Trades To avoid participating in a wash trade yourself, try to only exchange crypto on the platform or with people you can trust.
Additionally, watch out for some red flags like requests to transfer a similar amount of crypto for the same price back and forth. You can look up if the change in the number of unique addresses used to trade that coin correlates with the increase in volume. Additionally, you can directly look through the trades executed in the past few hours or days.
Since blockchains are transparent and have clear transaction history, this is a lot easier to do in the crypto market than with securities. FAQ What is an example of a wash trade? A wash trade is a type of trade that occurs when an investor buys and sells a security for the purpose of artificially inflating the price. This activity typically takes place on exchanges or other venues where the security is traded. Wash sales are considered illegal in most jurisdictions.
How do you identify wash trades? Some red flags might indicate that it was a wash trader who executed the transaction. For example, if one sees a couple of transactions with a similar price spread, trading volume, and time of execution coming in a row, this could be a wash trade.
What is a wash in day trading? A wash in day trading is a type of market manipulation that involves an investor buying and selling a security to artificially inflate its price. Not really.