What is wash trading?
Wash trading is known as buying and selling securities to provide the market with false information. In some cases, a trader and a broker can collaborate to complete wash trades by acting as both the securities’ buyer and seller.
By tricking investors into thinking that a security’s trading volumes are more significant than they are, wash trading can increase actual trading activity on the asset. Under U.S. law, wash trading is prohibited, and taxpayers cannot deduct losses from wash trades from their taxable income by the Internal Revenue Service (IRS).
Understanding Wash Trading
The federal government first outlawed wash trading following the passage of the Commodity Exchange Act in 1936, which amended the Grain Futures Act and required that all commodity trading take place on regulated exchanges.
Stock manipulators frequently used wash trading, which was illegal in the 1930s, to appear interested in a company artificially increasing its value and make money from short sales of the stock.
Brokers are also not allowed to benefit from wash transactions under restrictions set down by the Commodities Futures Trade Commission (CFTC), even if they assert that they were unaware of the trader’s intentions.
As a result, brokers need to conduct thorough research on clients before recommending that they purchase stock in a firm to achieve joint beneficial ownership.
Additionally, taxpayers are required by IRS laws to abstain from deducting losses resulting from wash sales, and the IRS has strong guidelines prohibiting wash trading. The IRS defines a wash sale as one that happens within 30 days of the security being purchased and ends in a loss.
High-frequency trading and wash trading
2013 saw a comeback of wash trading in the news, just as high-frequency trading was starting to gain traction. High-frequency trading involves making tens of thousands of transactions per second using high-speed computers and internet connections.
Given how simple it would be for companies using this technology to implement wash trading under the radar, former Commissioner of the Commodity Futures Trading Commission Bart Chilton declared in 2012 that he intended to look into the high-frequency trading industry for breaking laws related to wash trading.
The Securities and Exchange Commission (SEC) accused Wedbush Securities in 2014 of failing “to maintain direct and exclusive control over settings in trading platforms used by its customers,” which allowed some of the company’s high-frequency traders to engage in illegal and manipulative activities like wash trades.
Clean Trading and Digital Assets
In recent years, wash trading has also been more prevalent in the bitcoin market. Since there are hundreds of cryptocurrency tokens accessible worldwide and most of them struggle to stand out from one another, it is evident that the goal is to convey a sense of popularity and significant trading volumes. Wash trading occurs with even the most well-known cryptocurrencies, such as Bitcoin.
According to a Forbes investigation conducted in 2022 on 157 cryptocurrency exchanges, more than half of all recorded Bitcoin trading activity is either fraudulent or non-profit wash trading.
Pump-and-dump schemes, in which a combination of exaggerated trade volumes, significant publicity, or recommendations from insiders artificially enhance a token’s value, enabling select holders to sell at a substantial profit while interest is high, are especially susceptible to cryptocurrency holders.
The popularity of wash trading in cryptocurrency might be attributed to several factors. Even for significant digital currencies like Bitcoin, widely accepted methodologies only occasionally determine daily trade volume. As a result, cryptocurrency companies often provide drastically different estimates for previous trade volumes. Token exchanges have collapsed in several high-profile, public instances in recent years, and cryptocurrency exchanges often lack validity. High levels of volatility in the Bitcoin market might encourage quick purchases and sales. Finally, there is more room for deceptive trading behavior because of cryptocurrencies’ unclear position with U.S. and foreign government agencies.
Illustrations of Wash Trading
In essence, wash deals are trades with no economic value since they cancel each other out. However, they are used in a range of trade contexts.
In the LIBOR scam, wash transactions were utilized to compensate brokers who had rigged the LIBOR submission panels for the Japanese yen. The U.K. financial regulators have filed allegations alleging that UBS traders engaged in nine wash transactions with a brokerage business, resulting in 170,000 pounds in fees being paid to the firm for its involvement in manipulating LIBOR rates.
Wash trades may also inflate a stock’s price by creating fictitious volume. Assume that a brokerage company and trader XYZ conspire to purchase and sell stock ABC quickly. Other traders may invest in ABC after seeing activity in the stock to benefit from price changes. Then, XYZ shorts the store and gains from the company’s declining price movement.
Wash Trading: What Is It?
“Wax trading” is an illicit practice in which a single trader purchases and sells the same asset to provide false market data. It is often used fictitiously to increase a security’s trading volume.
What Does a Wash Trading Example Look Like?
The IRS defines a wash sale as one that results in a loss and occurs within 30 days of the identical security being purchased.
What makes someone engage in wash trading?
Wash trading may increase a security’s trading volume and encourage more honest trading. As part of a pump-and-dump plan, wash trading may also artificially raise the share’s price.
The Final Word
Wash trading is an unlawful practice in which a trader buys and sells the same securities on several exchanges or rapidly to inflate that security’s price or trading volume. Although wash trading may happen with a wide range of assets and sectors, it has lately gained significant attention in the high-frequency trading and cryptocurrency markets.
Conclusion
- In wash trading, traders and brokers conspire to manipulate the market using false information to benefit from the deal. This is an unlawful kind of trading.2 The Commodities Futures Trading Commission, “CFTC Glossary.”
- Wash trading is a tactic cryptocurrency exchanges and high-frequency trading companies use to influence prices.
- The IRS prohibits taxpayers from deducting wash trade losses from their taxable income.
