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Crypto: Solidus Labs uncovers $2 billion in 'wash trades', exec. explains

Decentralized crypto exchanges are seeing a rampant surge in "wash trading" activity — a form of market manipulation via artificial transactions on both mainstream and meme tokens — amounting to a minimum of $2 billion in overvalued assets being traded or in circulation.

Solidus Labs Co-Founder and Chief Experience Office (CXO) Chen Arad explains the crypto firm's latest report verifying wash trade volumes and how to best identify fraud across liquidity pools.

"Often times, wash trading is often used ultimately to inflate volumes and give the appearance of additional trading, more trading that actually happened," Arad says. "It's a good way for scammers or for people who often circulate malicious crypto tokens to create the appearance of activity, to drive prices up in a way that is unfair."

Arad also notes which crypto assets are being used to facilitate wash trading behaviors.

Video transcript

AKIKO FUJITA: Well, we saw Bitcoin briefly breaking above that 27,000 handle for the first time this month ahead of the Federal Reserve's interest rate decision in this week. And while traders look to push digital assets out of a muted range, a recent crypto market manipulation report spotlights a significant challenge to the crypto space.

Wash trading, that's a form of fictitious trade and fraud linked to market manipulation, has riddled the crypto industry. According to Solidus Labs, decentralized exchanges face $2 billion worth of wash trades since 2020. In an era of greater regulatory scrutiny, this adds a new wrinkle to the crypto market and traders.

Here for a deeper dive, let's bring in the founder-- co-founder and chief experience officer Chen Arad. Chen, it's good to talk to you today. Your report specifically highlights 67% of crypto trades manipulated by wash traders. What does that mean from a pricing standpoint?

CHEN ARAD: Thank you so much. It's great to be here. Important to say 67% of liquidity pools that we looked at-- liquidity pools are an important building block of every decentralized exchange. It's in practice where the trading happens. So again, this is a sample of the market. Of course, our goal here is to highlight that this is a challenge that these crypto markets are facing.

In practice, what it means is that in the parts of the market where this happens, in decentralized exchange where this happens, you know, traders ultimately face prices that are manipulated. Oftentimes, you know, wash trading is often used ultimately to inflate volumes and give the appearance of additional trading, more trading that actually happened. So you know it's a good way for scammers or for people who often circulate malicious crypto tokens to create the appearance of activity to drive prices up in a way that is unfair.

You know, important to say, you know, I always try to emphasize this, market manipulation is not a problem that just crypto deals with, right? Just this past month, the Department of Justice announced that two JPMorgan traders are sentenced to jail for manipulation of derivatives about that the bank admitted to about two years ago and also paid a $1 billion fine.

So again, wherever there are markets, there's manipulation. Crypto introduces a lot of new ways to do this, because it reinvents trading in some ways. And of course, our goal here is to highlight that this is a problem, but that there's a way to solve it. And it's actually easier to identify in a decentralized exchanges because of the transparency of the blockchain.

JOSH LIPTON: And so Chen, you talk about the impact here of this manipulation on investors. What are ways you think about how investors defend themselves, protect themselves from this?

CHEN ARAD: Right. So, you know, in a lot of ways, many of the merits of crypto and, specifically, DeFi, decentralized finance, you know, are also challenges. Ultimately, one of the goals of utilizing blockchain in order to create autonomous trading that doesn't depend on a centralized entity or bank or a company that runs an exchange is that they're more accessible. They're open. They're permissionless is the term we like to use in the industry.

But naturally, that also means that it's easier for scammers to try and take advantage of low-liquidity assets and, specifically, of traders that might not be aware of this. Again, a big part of the goal in this report is to raise awareness. One thing that we recommend is obviously anyone who engages in crypto, specifically with DeFi, it's a new market, you have to be aware, you have to be careful. But it's also very transparent. You can, through research, really learn what markets are more credible, what markets are less credible.

You know, I'll say, you know, of the 30,000 liquidity pools-- and again, those are the building blocks of decentralized exchanges-- that we looked at, we found-- of all of that volume, about 13% is manipulated. Some could argue that it's relatively low, lower than maybe some would have assumed existed in DeFi. So again, learn, study, look for a lot of publicly available information. And utilize the transparency in order to avoid being scammed and manipulated.

AKIKO FUJITA: Chen, what specific assets are we talking about? We started this segment by talking about where Bitcoin prices are right now, hovering close to that 27,000 handle. We're not talking about Bitcoin here, right? I mean, what are specific tokens that you've seen, especially inflated as a result of this?

CHEN ARAD: Right. Decentralized exchanges, you know, the largest decentralized exchanges are based off of Ethereum, not Bitcoin. And based off of Ethereum, there are a lot of other kinds of tokens that are built on that infrastructure. We're looking-- we look at around the tokens that we've identified that have been manipulated as part of the research. In this sample, there are more than 20,000 of them.

So oftentimes, the majority of those tokens are actually, you know, meme tokens, low-liquidity tokens. Oftentimes, you'll see scammers, manipulators issuing a token and then utilizing the way these markets work in order to wash trade, you know, in like the unique ways that you can do it. In decentralized exchanges, there are-- not all of these tokens are malicious. In some cases, you see manipulators that are, you know, just essentially attacking and manipulating completely legitimate and benign tokens.

But generally speaking, wash trading is most effective for manipulators when they're looking at low-liquidity, less-known tokens. Oftentimes, those are meme tokens, very buzzy tokens, where people don't think a lot. They kind of put money quickly because they want to make a lot of money, kind of don't think about the risk for a second. And then through this sort of wash trading, which, you know, because of the open nature of these markets, in some ways, it's easier to execute, you know, would create the appearance of volume to attract, you know, innocent traders to invest in them.