Uncovering Wash Trading: Illegal Trading Tactics and Their Impact on Markets

Wash trading is one of the most common forms of market manipulation, where traders and brokers systematically cooperate to execute transactions without economic risk. By intentionally buying and selling the same securities or digital assets, artificial trading volumes are created, misleading potential investors. This trading tactic is not only prevalent in traditional financial markets—it has long since infiltrated the emerging world of cryptocurrencies.

The Basics of Market Manipulation through Wash Trading

Wash trading refers to an illegal trading practice where an investor simultaneously buys and sells the same security. The term derives from “round-trip trading,” as traders ultimately hold the same assets in their portfolios as before—only the transactions on paper have increased.

The primary goal is to distort market perception. Through artificial trading activity, participants attempt to attract legitimate buyers and drive prices upward—or simulate selling pressure to lower prices. In many cases, brokers and investors share the profits from this manipulation. The broker can benefit from commissions paid by other investors reacting to the artificially inflated prices, while the investor can realize immediate gains through targeted short selling or price manipulation.

Experts often describe this cooperation as a form of insider trading, since both parties have prior knowledge of the transactions to come. A telltale sign is when a trade does not change the overall market position or when the asset never actually changes ownership—these are often purely paper trades.

Historical Development: From 1934 to Modern Regulation

The history of wash trading dates back several decades. Before 1936, stock manipulators deliberately used this tactic to signal false interest in certain stocks and artificially inflate their value. This allowed them to make significant profits through short selling.

The United States responded with clear regulation: the Securities Exchange Act of 1934 first outlawed these practices legally. This was further tightened by the Commodity Exchange Act in 1936. Today, the Commodity Futures Trading Commission (CFTC) oversees compliance with these laws in the U.S. In American law, wash trading is unequivocally illegal—a status shared by many other countries.

Despite these bans, the practices have never truly disappeared. They have merely adapted to new markets and technologies.

Wash Trading in the Cryptocurrency Market: Unique Challenges

The rise of cryptocurrencies has revived wash trading in new forms. Many crypto projects intentionally try to create the impression of popularity and enormous trading volumes. It’s not just low-market-cap coins—established assets like Bitcoin have also been affected.

The reasons for this development are clear:

• For major cryptocurrencies like Bitcoin, there is no universally accepted standard method for calculating daily trading volumes. As a result, exchanges can report different—and sometimes significantly divergent—numbers for historical transaction volumes, creating opportunities for manipulation.

• Many cryptocurrency exchanges lack official regulation and government legitimacy. The repeated and sometimes spectacular collapses of several crypto exchanges in recent years highlight these vulnerabilities in the ecosystem.

• The extreme volatility of the crypto market promotes rapid buy and sell cycles, making it harder to distinguish suspicious patterns from legitimate trading activity.

• The uncertain regulatory status of cryptocurrencies at U.S. and international levels adds further uncertainty and loopholes for manipulators.

How Wash Trading Works: Mechanisms and Execution

For genuine wash trades to occur, typically two key conditions must be met:

Intent to manipulate: The broker or investor must deliberately and consciously execute transactions with the goal of deceiving the market. This is not accidental or incidental behavior but calculated.

Identity of economic ownership: Investors must have bought and sold the same asset within a short period for accounts with the same or related economic ownership. In other words, the accounts belong to the same person, company, or connected entities.

Accountants and regulators may suspect wrongdoing if they observe accounts with shared ownership engaging in unusual transaction patterns—that’s often the first warning sign.

Another characteristic is that such trading activities do not expose the security or asset to real market risk. The position remains effectively unchanged. Sometimes, these “transactions” are only documented on paper, without the asset actually changing hands.

Detecting and Preventing Wash Trading Activities

To identify wash trading, regulated institutions and authorities look for unusual or atypical trading patterns among market participants. Any suspicious activity—such as buying and selling within very short timeframes that have no noticeable impact on profit or loss—is flagged and investigated.

Strict and continuous trading surveillance is the only effective method to detect such activities promptly. Modern monitoring systems utilize algorithms and data analysis to identify suspicious patterns.

Once a company or authority uncovers a case, swift action is necessary. Findings must be reported immediately to the relevant regulatory agencies. Legal steps should also be initiated to remedy damages and prevent future violations.

Additionally, financial firms should regularly review and update their internal compliance programs. This helps identify existing vulnerabilities that may have enabled or facilitated wash trading activities.

Frequently Asked Questions about Wash Trading

Can wash trading occur in NFT trading?

Yes, the phenomenon extends to the non-fungible token (NFT) market. Buyers and sellers of NFTs can employ wash trading tactics to artificially inflate prices. A typical scenario: the initial sale is made public and generates attention. Afterwards, the piece is repeatedly traded between the same parties to create the illusion of rising demand and value. In the next exchange, money and NFT ownership are transferred back to the original seller—closing the loop.

Are wash trades truly illegal?

According to U.S. law and the Commodity Futures Trading Commission (CFTC), wash trading is clearly illegal. The legal prohibition has been in place for decades and is supported by regular enforcement actions.

Why would someone engage in wash trading at all?

The incentives are varied. First, wash trading can significantly inflate the trading volume of securities, attracting legitimate investors and leading to more genuine trading activity—thus amplifying the deception.

Second, wash trading can be used deliberately for price manipulation within a “pump-and-dump” scheme: perpetrators artificially drive prices higher (“pump”), attract uninvolved investors, and then sell their holdings for profit (“dump”)—while new buyers face falling prices and losses.

Such manipulations ultimately harm the entire market, undermine trust in exchanges, and endanger the assets of average retail investors.