• CFRED CUHK Law

FinTech and RegTech: The Case of Cryptocurrency Exchanges

Will Cong – Cornell University


-- Morning Keynote Paper, Machine Lawyering Conference 2021, Day Two -- The rapid developments in FinTech raises many legal and regulatory issues. Corresponding RegTech for detecting market manipulation is needed and the case of cryptocurrency trading provides an illustration. Since Bitcoin’s inception in 2008, thousands of cryptocurrencies and blockchain projects have emerged. The market capitalization of all cryptocurrencies peaked at 828 billion USD in Jan 2018 and is around 660 billion USD as of December 2020. Yet, crypto exchanges, arguably the most profitable players in the ecosystem, remain mostly unregulated with less than one percent of the transactions taking place on regulated crypto exchanges.

Against such a backdrop, in the paper “Crypto Wash Trading,” we examine whether crypto exchanges exhibit empirical regularities observed in traditional financial markets in nature and in general. We use proprietary data on 29 representative cryptocurrency exchanges, including 3 regulated ones. By inspecting the distribution of first significant digits of trade size which should follow Benford’s law, the clustering of trades at round numbers, and the tail distribution of trade sizes traditionally described by power law (Pareto-Levy law), we find that most unregulated exchanges wash trade (fabricating trades and acting as the counterparty on both sides to inflate volume).


We further quantify wash trading to be as high as 77.5% of the total trading volume on the unregulated exchanges, with a median of 79.1%. In particular, wash trades on the twelve lower ranked exchanges are estimated to be more than 80% of the total trade volume which is still over 70% after accounting for observable exchange heterogeneity. These estimates, combined with the reported volumes in Helms (2020), translate into wash trading of over 4.5 Trillion USD in spot markets and over 1.5 Trillion USD in derivatives markets in the first quarter of 2020 alone.


To rule out the influence of heterogeneity of traders and algorithmic trading strategies across various exchanges, we validate the roundness-ratio estimation by a standard leave-one-out cross validation (LOOCV) strategy for regulated exchanges, fitting unrounded trades using Benford’s law and power law, and adding exchange characteristics as controls. We also provide alternative measures that similarly demonstrate statistically and economically significant wash trading on a majority of unregulated exchanges.


To better understand the phenomenon, we study exchange characteristics that correlate with wash trading and investigate the impact of wash trading on market outcomes such as exchange ranking. In addition, we show that exchange ranking depends on wash trading (70% wash trading of total reported volume moves an exchange’s rank up by 46 positions). We find that an exchange’s wash trading is positively correlated with its cryptocurrency prices over the short term. We also find that exchanges with longer establishment history and larger userbase wash trade less. Less prominent exchanges, in contrast, have short-term incentives for wash trading without drawing too much attention. Moreover, wash trading is positively predicted by returns and negatively by price volatility.


Wash trading fueled by current business incentives and public ranking is rampant on unregulated crypto exchanges. Yet, regulated crypto exchanges, having committed considerable resources towards compliance and license acquisition and facing severe punishments for market manipulation, do not appear to wash trade. It is also possible that regulatory compliance serves as a screening tool that manipulative exchanges do not acquire licenses. Our systematic demonstration of the direct or screening effects of regulation in the cryptocurrency markets has implications for investor protection and financial stability.


As the first comprehensive study of the pervasive crypto wash trading, our paper not only provides a cautionary tale (and a set of RegTech tools in the cryptocurrency market for convincingly exposing wash trading of exchanges and potentially combating non-compliant exchanges) to regulators around the globe but also reminds the readers of the disciplining or screening effects of regulation in emerging industries, the importance of using wash-trading-adjusted volume in ongoing lawsuits and future empirical studies, and the utility of statistical tools and behavioral benchmarks for forensic finance and fraud detection. More broadly, we highlight the importance of regulation and RegTech in response to the rise of FinTech.

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