Decentralized exchanges are generally liked for their transparency and lack of custody, reducing the trust requirements in their operators.
Many centralized exchanges have been caught in a peculiar type of manipulation used to inflate their trading volumes. This was first highlighted by the Bitwise Report released in March 2019, which analyzed trading patterns on some of the platforms to conclude that up to 95% of reported Bitcoin trading volume at the time was essentially fake.
One of the ways to inflate volume is the practice of wash trading, where a single entity acts as both the maker and taker of an order, essentially trading with itself. While wash trading mostly just benefits the exchange by inflating its reported statistics, incentive schemes like transaction fee mining have been used by some exchanges to reward users for wash trading.
While self-custody is an important value proposition for DEXes, being based on a blockchain ensures transparency in how the exchanges operate. Every trade is generally recorded in a public database, which makes it easy to detect misbehavior.
It may come as a surprise then that some DEXes are seeing quite obvious wash trading occur on their platforms.
Binance DEX and the Travala token
The decentralized exchange launched by Binance has at least one pair with fairly easy to detect wash trading.
The token of the Binance-backed project Travala (AVA) is one of the highest volume pairs for Binance’s token BNB.
An initial clue into wash trading is its volume chart. One of the tactics used by Bitwise to detect fake volume were their detailed patterns. Normally, tokens will have wild volume spikes between low and high volatility periods, with clearly identifiable peaks as prices move strongly in a particular direction.
On AVA/BNB, volume is uniformly high when volatility is low, while during price spikes it actually drops, instead of rising.
AVA/BNB chart on Binance DEX
But since it is a decentralized exchange, conclusive proof of the wash trading can be obtained through the block explorer. For example, two accounts can be seen placing orders every minute for about 5 to 30 BNB each, or about $80 to $550. Since the orders are for the exact same amounts and are delayed by at most a few seconds, it is very likely that they accounts are owned by the same entity.
These two wallets are responsible for about 18,000 BNB ($316,000) of 24 hour volume, out of a reported total of slightly less than 30,000 BNB ($500,000).
When contacted, a Binance spokesperson told Cointelegraph:
“Binance DEX is a decentralized platform. Binance has no control on the order flow, in the same way as no one can control the order flow into Uniswap. It is also a transparent network as the link is evidence. We stand with the community to denounce any market manipulation.”
While the perpetrator could be anyone, it remains unclear why someone would perform wash trading on a platform without any benefit to themselves. Binance did not answer specific questions on what the possible motivation could be. It is worth noting that other pairs on the DEX do not seem to be affected by wash trading.
Loopring often shows the same wallet as maker and taker
On the zkRollup-based DEX Loopring, the wash trading is even easier to see. The platform seems to be allowing the same wallet address to act as both the maker and taker of an exchange transaction.
The latest snapshot of its trades, captured by Dune Analytics, shows how the majority of the transactions are done by a few wallets trading various assets with themselves, a clear sign of wash trading.
Loopring DEX transactions. Source: DuneAnalytics
In an email conversation with Cointelegraph, Loopring’s head of business development, Matthew Finestone, acknowledged the issue, noting that “there is occurrence of self-trading.”
He explained that there are a variety of actors who may be interested in doing wash trading, including Loopring itself:
“When it's us, indeed, it is to bootstrap some liquidity - simply create some initial volume to get the ball rolling. That can be to create a line chart for a new pair, or indeed, just to sustain activity, so organic users can come in and feel welcome. When it's others, it is for a few reasons, but basically to earn rewards!”
Finestone noted that Loopring has plans to step its own self-trading down but none to prevent others from doing so:
“Curtailing it when it is others is effectively censorship. It is us imposing our will about what is/isn't a good trade. That is definitely something we don't want to do - especially since it is something we CAN do.”
Loopring is a layer two-based exchange based on zkRollups, where transactions are processed off-chain but are then settled in compressed batches on Ethereum. Finestone noted that such a solution only guarantees self-custody, though “censoring trades is bad business.”
He added that Loopring often organizes trading competitions and liquidity mining incentives that could spur others to engage in wash trading. Furthermore, he suggested that part of the activity may also come from projects wishing to boost liquidity for their tokens. “In many cases, anecdotally, it is people spinning up their bots and simply testing their strategies,” he concluded.
DEXes not immune from wash trading, but it’s not outright tampering
Finestone concluded his thoughts by highlighting that wash trading on decentralized exchanges is still different:
“DEXes are not impervious to wash-trading. Not at all! It is simply the case that they (or whomever) must pay for this act. Trades that settle on Ethereum cannot be spoofed. They really do settle. They really did pay gas.”
By contrast, there are no guarantees that wash trading done on centralized exchanges pays fees. If it is an exchange itself that organizes it, it could simply manufacture trades at no cost, he explained.
“In our case, and all DEXes, it was there, it settled, it just wasn't the economic intent we all may have wished for,” said Finestone.