Billionaire Mark Cuban believes an age-old market manipulation tactic could be the next thing to rock the cryptocurrency industry.
"I think the next possible implosion is the discovery and removal of wash trades on central exchanges," the longtime crypto investor tells TheStreet.
A wash trade is when a trader buys and sells the same financial asset multiple times in order to generate fake volume and make it appear as if there is a high demand for the asset. This artificially inflated demand can mislead other traders into investing real money into the asset.
Since higher demand typically leads to higher prices, traders can use this process as a type of "pump-and-dump" scheme: When the price is as high as the trader thinks it can go, they can cash out and leave other investors with the asset that's declining in value.
Although wash trading has been illegal within traditional U.S. financial markets for decades, it's likely difficult to crack down on the activity within the crypto space.
Putting an exact number on crypto wash trading is much harder than in traditional finance because the markets are so different and decentralized.Chen Aradchief operating officer, Solidus Labs
"Putting an exact number on crypto wash trading is much harder than in traditional finance because the markets are so different and decentralized," says Chen Arad, chief operating officer at Solidus Labs, a crypto-native risk monitoring and market surveillance company.
For example, bitcoin is traded across thousands of platforms that are both centralized and decentralized, regulated and unregulated. This can create new openings for criminals to collude across exchanges and manipulate the market in new and sophisticated crypto-native ways, Arad tells CNBC Make It.
To that point, a little over 50% of daily bitcoin trades being reported are likely fake, according to Forbes' latest analysis of 157 crypto exchanges across the world. For the study, Forbes analyzed data from four crypto media firms — CoinGecko, Nomics, Messari and CoinMarketCap — as well as multiple crypto exchanges.
Although Cuban cautioned that he didn't have any specifics to support his prediction, he pointed out that there are supposedly tens of million of dollars in trades for digital tokens that have very little utilization, and he doesn't see how those types of assets could be so easily converted into cash.
Arad agrees that wash trading is a major issue within the cryptocurrency market. "Without stymying wash trading, crypto will never fulfill its potential to enable more safe and accessible financial services," he says.
Unfortunately, spotting wash trading on your own is no easy feat. Identifying market manipulation requires specialized technology and deep technical, financial and crypto expertise, says Arad.
But it's important to note that the crypto industry has made a concerted effort to combat the issue over the years, he says.
"Most regulated exchanges have compliance and surveillance teams larger than in traditional finance and led by expert veterans," Arad says. "On exchanges that use market surveillance, the rate of wash trading is often just a fraction of a percent."
The best thing that retail investors can do to protect themselves from falling for a wash trading scheme is to ensure that they only trust regulated crypto platforms that utilize market surveillance technology to detect suspicious trading activity, he says.
Sign up now: Get smarter about your money and career with our weekly newsletter
Don't miss: Bitcoin lost over 60% of its value in 2022—here’s how much 6 other popular cryptocurrencies lost
