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Fraud at Crypto Centralized Exchanges is Rampant

ethereum transactions
Source: https://etherscan.io/chart/tx

According to CoinMarketCap data, there are more than 2,400 cryptocurrencies in circulation today, with a combined market cap of over $223 billion. Bitcoin, Ethereum and XRP account for the maximum valuation and the highest volumes. Majority of the trading volume is driven by crypto exchanges, which are of two types- centralized and decentralized (DEX). Centralized crypto exchange is a platform that has a central “authority” matching and running the trades. Centralized crypto exchanges are currently dominating the volumes due to low liquidity on DEXs and higher throughput on centralized platforms that is critical to power algo and high frequency trading. But centralized has always been in the crosshairs of blockchain purists because it stands against the original Satoshi principle of decentralization.

The frauds in crypto centralized exchange have also increased in the last few years. According to a new report from CipherTrace Cryptocurrency Intelligence, bad actors stole $1.7 billion worth of cryptocurrencies from investors last year. Of that total, roughly $1 billion was taken from exchanges.

But there is an even bigger fraud rampant in centralized crypto exchanges. The 24 hour volume of crypto assets as reported by CoinMarketCap was ~$58 billion (as on October 22, 2019. But according to research conducted by Bitwise, 95% of Bitcoin trade is fake.

Bitwise to SEC
Source: CoinTelegraph

Bitwise conducted research on data of 83 exchanges. It found that approximately 95% of the reported BTC trading volume is fake and only 10 exchanges had 100% “real trading volumes”. If you think that is too pessimistic, consider another research on fake volume exchanges done by Alameda Research in which they studied the data of 48 exchanges. The research found that the fake crypto volume was an estimated 68%. Not as bad as Bitwise, but the report does no favor to the centralized exchanges industry’s reputation.

The Why

What is the harm in faking volumes? You might believe that this fake volume is necessary to attract investors and traders and is par for the course. But wash trading is a cottage industry in itself and the final purpose is extremely sinister.

fake exchange volume
Source: CoinDesk

Pumping volume is on sale and it will cost you a mere $6000 a month for fake trading via algorithms that imitate normal trading activity. But why pony up $6000? These are not market makers who are here to support investors find liquidity in new coins. The goal is a critical part of “pump and dump” schemes which have led to crypto investors losing tens of billions of dollars in wealth on betting on such coins.

An EY report in 2018 concluded the following:

  • 86% of ICOs are below their listing price
  • 30% of them have lost almost all value
  • $15 billion  was reported to have been raised in first half of 2018 alone.

On an average basis, this might translate to a loss of over $5 billion on ICOs in 2018 H1 alone.

So stealing crypto is a major issue but a much bigger perpetually running scam is that of fake volumes. It draws gullible investors to invest in fly-by-night operators who use the illusion of liquidity and high prices to dump billions of dollars of worthless coins.

Exchange Analysis:

Centralized exchanges are the key facilitators of this fake volume scam. Some of them just look away as it is difficult to say no to transaction fees being generated. But many are active participants who know and even facilitate such wash trading on their platforms. It is a win-win relationship. With more volume on their exchange, they not only generate revenue but also start climbing on the charts for exchanges that helps them catch the attention of bigger crypto traders.

The situation has gone so out of hand that analysts have started naming and shaming exchanges like HitBTC, Huobi and OKEx. CoinMarketCap now shows volumes under two heads- reported volume and adjusted volume.

These are the top 10 exchanges by adjusted volume (this volume does not include trading with no fees and transaction mining).

crypto Exchanges

And now for the top 10 exchanges as per the reported volume:

crypto exchanges

The top 2 players as per reported volume are not even in the top 10 of the adjusted volume list.

Transaction Analysis:

ethereum transactions
Source: Etherscan

The number of transactions has increased marginally from November 2017 to September 2019. But the volume has exploded.

Ethereum Volume in November 2017 was somewhere in the sub billion dollar a day range.

Market Cap

But now consider October 2019 and you can bet there is an anomaly in the data.

Market Cap Oct 15

The 24 hour volume has increased by more than 700% but the number of transactions have not even doubled. Assuming a 4x rise in volume per trade is just not rational.

Regulated Players

Regulated players like Bakkt (promoted by Intercontinental Exchange) and CME have obviously stringent KYC and AML laws and ensure all trades are genuine. These players are well incorporated in the existing financial system and their introduction of trading in crypto assets will ensure that institutional players can participate knowing their funds (and reputations!) will remain intact.

Conclusion

Although cryptocurrency trading is now mainstream, centralized crypto exchanges have not been able to stamp out fake trading. The future lies with regulated players like Bakkt and CME stealing a march as they attract genuine deep-pocketed investors. Another interesting development is the growth (albeit slow) of decentralized exchanges who can help stamp out the fake trade issue as well.

Author:

Written by Heena Dhir.

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Allen Taylor

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