Wash Trading Meaning: All You Need to Know About This Illegal Activity

6 min read

You’ll encounter many trading strategies if you’re venturing into cryptocurrency trading. Along the way, you might stumble upon the term “wash trading crypto” in online discussions or forums. However, it’s crucial to note that wash trading is not a strategy you should entertain under any circumstances.

Wash trading is not only intricate and bewildering but also entirely illegal. It involves a specific technique that traders employ to deceive fellow investors into believing that a particular cryptocurrency is more popular than it is, leading them to purchase it at an inflated price.

But let’s take a step back. If you’re new to crypto trading, the jargon can be overwhelming. Therefore, let’s establish some common ground and delve into wash trading in crypto, including its implications for taxes and more.

What is Wash Trading?

Wash trading is not a new concept; it has been prevalent in various financial markets, including stocks, for decades. In the cryptocurrency industry, wash trading functions similarly to its use in stock markets.

Basically, wash trading involves a trader rapidly buying and selling a security to inflate its price and deceive other investors artificially. The crucial aspect to note here is the intention behind these actions, which we will delve into later in this article.

Wash trading can be carried out by an individual trader, a group of traders, or even in collaboration between traders and brokerage platforms. The involvement of some exchanges in wash trading makes it challenging to trust specific crypto trading platforms. Hence, thorough research is essential when engaging in crypto trading activities.

It’s important to emphasize that wash trading, whether it involves Bitcoin or any other cryptocurrency, is completely illegal

Example of Wash Trading

To better understand wash trading, let’s examine an example:

Imagine you are a crypto enthusiast willing to explore unethical means of making a profit. You decide to investigate how to wash trade crypto and devise a plan.

First, you select a crypto coin or token; let’s call it JohnDoeCoin. You begin rapidly buying and selling this token, executing trades so quickly that they nullify each other. Whether you make a profit or loss during these initial trades is inconsequential.

Now, another trader enters the market. If they observe the JohnDoeCoin token, they will notice its impressive trading volume, suggesting high liquidity and a growing price. From their perspective, the JohnDoeCoin token appears to be an ideal short-term investment opportunity. However, unbeknownst to this investor, your wash trades artificially inflate the token’s price. Once the investor purchases the token at the inflated price, you sell your holdings, making a profit and leaving the unsuspecting investor disadvantaged.

It is crucial to understand that not only is this practice illegal, but it is also relatively easy to identify if one knows what to look for. Therefore, abandon the idea immediately if you contemplate engaging in wash trading in the crypto market. It is a criminal act that could result in severe consequences.

The above example illustrates a simplified scenario of wash trading in crypto. Variations exist, most commonly when cryptocurrency brokers collude with specific investors to facilitate wash trading in selected cryptocurrencies. While this may sound unbelievable, it is important to recognize the diverse range of investors in the market. Some are retail investors, while others are high-profile individuals with substantial backing. This diversity can lead to covert agreements and, unfortunately, instances of wash trading.

Understanding the Principal Motives Behind Crypto Wash Trading – Maximizing Profits and Avoid Tax Deductions

Evidently, individuals engage in crypto wash trading primarily to maximize potential profits quickly without considering ethical or legal implications. However, another motivation for learning about wash trading in crypto is tax deductions.

It’s important to note that the following assumption is flawed, and legal systems have measures to prevent abuse. Understanding how some traders think and what leads to washing trading activities is valuable.

During wash trading, you may intentionally accumulate significant initial losses while planning to sell your tokens later for expected substantial profits. Interestingly, these artificial losses could also be utilized when filing taxes.

Depending on the tax laws in your country, losses incurred during the tax year can often be deducted from your tax liability. Therefore, if you have accumulated substantial profits and anticipate a significant tax obligation, the idea of creating artificial losses to reduce your taxes may seem tempting.

However, it’s essential to emphasize that attempting to wash trade for tax deduction purposes is futile. Let’s consider the example of the Internal Revenue Service (IRS).

The IRS has safeguards in place to address such scenarios. Losses incurred through wash trading within the initial 30 days of acquiring the asset are deemed wash trades by the IRS. Moreover, these wash-traded amounts are excluded from your tax deductions. In other words, while you might initially succeed in wash trading, you won’t be able to utilize the resulting losses to reduce your tax liability.

This underscores the significance of understanding what wash trading entails in crypto. While wash trading crypto for tax purposes might appear appealing, a comprehensive examination reveals its inherent flaws. Regardless of how you approach it, attempting to exploit wash trading for tax deductions is ultimately ill-advised.

Tips for Avoiding Wash Trading in Crypto

Now that you know more about wash trading, preventing yourself from falling into this trap is crucial to safeguarding your investment portfolio. To simplify the process, here’s a concise outline of the actions you should take to protect yourself from wash trading in the crypto:

Analyze Trading Volume

  • Assess the trading volume of a specific crypto project.
  • Consider the project’s popularity and trading volumes with its age, mainstream news coverage, and online presence.
  • Use common sense and critical thinking to determine if the trading volumes align with the project’s genuine popularity.
  • Investigate further if the numbers seem suspicious or don’t add up.

Explore Blockchain Data

  • Utilize blockchain explorers to gain insights into token transactions.
  • Examine the number of wallets holding the most tokens.
  • Look for any unusual mechanics on the platforms themselves.
  • Identify individuals engaging in rapid trading of the asset.
  • Pay attention to wallets that consistently trade without reaping actual benefits.

Consider NFT Trading

  • Inspect NFTs on the blockchain or use NFT marketplaces like OpenSea.
  • Look for wallets repeatedly trading the same NFT multiple times daily without making profits.

Choose Reliable Exchanges

  • Recognize the role of exchanges and brokerages in wash trading.
  • Select reputable platforms with a proven track record of reliability.
  • Prefer exchanges that prioritize customer satisfaction and promptly address issues.

Conclusion

If you were initially interested in exploring wash trading as just another trading strategy, we hope this article has clarified why you should avoid it. 

Remember, trading on reliable and reputable cryptocurrency exchanges is the simplest way to avoid crypto wash trading. Consider platforms like Binance, Coinbase, and Kraken, among others.

Lastly, if you’re eager to explore genuine crypto trading strategies or learn about cryptocurrency trading signals, be sure to explore our dedicated articles on these topics. They will undoubtedly assist you in becoming a more skilled crypto trader and investor.

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