Bitcoin Wash Trading

Is It A Hoax?

By Steven J. Grisafi, PhD.

The Wall Street Journal has reported a disturbing new study, conducted by Bitwise and reported to the Securities and Exchange Commission as part of their effort to create an exchange traded Bitcoin fund, that appears to indicate that most Bitcoin trading is wash trading: an entity serving as both the buyer and the seller in the same Bitcoin transaction. This information is so disconcerting that it requires further examination because it shakes the foundation of all future blockchain based structures that utilize mining as the means of rewarding the efforts to maintain the public ledger. I focus immediately upon mining as the suspected cause of this anomaly, because every Bitcoin transaction costs money.

No one can know how many have fallen into this particular ruse, but for those who came late to the Bitcoin craze, a particular scam that has been perpetuated upon them is the practise known as “Sweeping.” At times an owner of Bitcoin may need to transfer Bitcoin from one wallet to another. Disingenuously the recommendation had been given that this procedure is best accomplished by “Sweeping” all coins from one wallet to another. However, doing so incurs a transaction and its subsequent cost. Nowadays this cost is quite significant and ranges upon the order of fifteen United States Dollars. For persons owning only small amounts of Bitcoin this procedure can preclude all further trading because a single transaction may cause the wallet balance to fall below the threshold for minimum transaction costs. As a result, the content of the wallet becomes inaccessible until further Bitcoin is (quite foolishly) purchased elsewhere.

I do not suppose that the Sweeping Ruse can be the cause of this inordinately high discrepancy suggested as wash trading, but I do believe the cause lay within mining. Those who mine Bitcoin are the only ones who could benefit from wash trading. When someone seeks to sell Bitcoin from one account to another maintained within the same wallet one must pay a transaction fee. That fee accrues to the account of the successful miner who solves the computation for the block containing the transaction. Unless one is virtually assured of solving that particular computation for the block holding the transaction, wash trading becomes a losing proposition serving no purpose. Since all block computations are difficult, and there are no known guarantees to a mining operation that it will succeed over its competition, wash trading is disadvantageous. Unless, of course, there is collusion amongst miners who coordinate their mining activities with one another.

Even so, even if miners were to coordinate their mining intensity such that one can prevail a certain times, while allowing friendly competition to prevail at another, I tend to doubt that mining entities are so dedicated to the future of blockchain technology such that they would take such extraordinary steps to promote this illusion of its success. I tend to believe more that the suspected wash trading results from accounting errors within the blockchain as it undergoes aggregation. For example, the effect of anomalous branching of the blockchain resulting in orphan blocks can multiply the appearance of trading activity. If that can be sufficient, no one knows for sure. But orphan branching seems far more likely to me to be the cause of the anomalous over-activity in trading than deliberate wash trading.