Whether you want to believe it or not, crypto is by no means except from market manipulation. 

In fact, a recent report from crypto research firm ’Solidus Labs’ called ‘The 2023 Crypto Market Manipulation Report’ has revealed the extent to which large players are fiddling with crypto antics.

The report focuses on two of specific market manipulative frailties: insider trading and wash trading. By uncovering the statistics behind such illicit behaviours, the report provides insight into how insider and wash trading occurs in crypto, which in turn can help the space devise better strategies to proficiently tackle them. 

Let’s get into the report…

Insider Trading 

Before we get into things, it’s important to first note how the authors define insider trading. 

Although not a 100% accurate measure, the report deems ‘insider trading’ as any wallet that repeatedly buys a token a few days or hours before it’s listed on an exchange. Through identifying these wallets, inferences can then be made with regards to the coins and projects involved.

Per the report, most insider trading activity takes place on decentralised exchanges (DEX), where in a ploy to evade so-called ‘insider trading detectors,’ there were only a few instances of coins being sold on centralised exchanges (CEX). Of course, the reason for this is the ambiguous and pseudonymous nature of the former. 

Further, crypto insider trading was found to take place a lot more frequently than publicly traded companies - where for TradFi-related context, insider trading before earnings announcements of public companies takes place around 5% of the time, as well as 20% of the time before mergers and acquisitions.

In contrast, the report states that a whopping 56% of ERC-20 tokens listed on crypto exchanges in 2021 had evidence of insider trading. Here we could expect rates to be even higher for coins on other blockchains.

When it comes to the culprits of such activities, the report identifies token issuers, market makers, and investment firms as the most predominant entities involved. 

Quite dauntingly, it also speculates that crypto exchanges themselves may be guilty too - as showcased through the arrest and 3-year sentence of a former Coinbase manager earlier this year. 

Collectively, these four entities are deemed as the only ones to have access to material nonpublic information (MNPI) - i.e. the resources required for proficiently carrying-out insider trading.

And when it comes to the methods used for covering tracks after leveraging MNPI, the study cites privacy protocols such as Tornado Cash, smart contract-enabled privacy coins like Secret Network, and of course, crypto exchanges that don’t require KYC. 

In finally referring back to the definition of insider trading, the report also notes that some insider trading findings may actually be instances of copy trading or traders simply getting lucky. 

Wash Trading

Wash Trading is the process of purposefully trading high volumes of assets in a ploy to artificially inflate their respective prices and activity levels. 

In getting straight to the stats, the report states that liquidity providers on Ethereum have wash-traded over $2 billion worth of crypto since 2020 (… yes, that’s just on Ethereum). 

Here, it also finds that over 20,000 cryptocurrencies have been involved in wash trading, whilst 67% of the 30,000 DEXs in the study have been manipulated by wash trading at some point (with the authors also speculating that these figures could be magnitudes higher when looking at the entire crypto ecosystem).  

The main culprits involved in wash trading were identified as crypto exchanges, Web3 marketplace operators, market makers, token deployers, and individual speculative traders. These entities mainly engage in two types of DEX-residing wash trading - ‘A-A’ and ‘multi-party’ wash trading.

The former here relates to providing liquidity and making swaps using one wallet, whilst the latter involves multiple wallets (which are often controlled by the same individual). Per the authors, these two methods are deployed almost equally across wash trading ventures, with the latter coming out as slight favourite. 

When it comes to the specifics of what these methods may involve, some crypto projects implement on-chain mechanisms that don’t allow new buyers to sell, whilst more simply, some use multiple wallets to falsely represent traders FOMOing and aping-in on their coins…

In turn, this then encourages unbeknownst legitimate traders to FOMO into a shitcoin/rug pull. Of course, the desired outcome is often achieved through this, as the respective price and volume of a coin will become inflated. 

It was also found that the majority of wash trading occurs on CEXs, as whilst profits are initially dented by the on-chain fees of DEXs, these can be counteracted once ‘artificially-pumped’ coins are listed and sold on CEXs. 

On the bright side, wash trading is largely deemed as a detectable and preventable issue, as DeFi protocols have the potential to develop similar anti-wash-trading technologies that CEXs use. This includes on-chain analytics tools that can identify suspicious liquidity providers. 

Closing Thoughts  

Interestingly, issues of insider and wash trading form the basis of the Securities and Exchange Commission’s (SEC) aversion to crypto - further meaning that they also have a bearing on the success of the several in-waiting spot Bitcoin ETF applications (however that being said, this then begs the question ‘how rife are these issues in Bitcoin ecosystem?’).

However rather optimistically, the general sentiment across ‘illicit crypto activity’ is that insider and wash trading are relatively easy to solve - and that in reality, crypto’s biggest setbacks come in the form of centralisation, privacy, and censorship-resistance (so perhaps expect a report overview of these topics some time soon). 

To tackle them, applying regulations on the smart contract level has been identified as a productive measure, as these can essentially identify which DEXs are legit. In fact, this is something that Ethereum and BNB developers and are currently working on. 

That being said, there are still conflicting views across the space (from ’Solidus Labs’ as well as other crypto investigators) regarding whether CEXs or DEXs are bigger hotbeds for illicit crypto activities. However with the latter having transactions publicly viewable and traceable, it can be said that DEXs are the lesser of the ‘two evils’ here. This is because crypto assets essentially go into the DeFi abyss once placed in the hands of CEX crypto wallets (with the exception of the platforms themselves having intel).

In conclusion however, the consensus revolving around the ‘ease of solution’ here flies in the face of what many mainstream sceptics believe, as explicit decentralised finance often screams ‘illicit behaviour’ to those outside of the space. 

On the contrary however, DEXs and their wealth of transparent features appear to be a safer solution than their centralised counterparts (which are controlled by a small cohort of individuals that can be corrupted through their flawed human instincts and insecurities). 

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This article is intended for educational purposes and is not financial advice.