Georgina Chong lowers her glasses, the harsh light from the fluorescent lamp on the ceiling revealing the subtle crow’s feet around her eyes. Her long lashes immaculately curled and flitting rapidly like a butterfly on speed, she inspects the handbag set before her like a Christie’s valuer would appraise a Monet.
A ruby encrusted ring set with an accompanying pair of 2-carat trapezoidal diamonds adorns Chong’s sublimely manicured finger as she smooths over the leather of the Hermès bag, inspecting ever single grain of the calf leather (poor cow never had a chance) looking for signs of flaws or imperfections.
But Chong is not in some high-end boutique on one of Singapore or Hong Kong’s most exclusive shopping belts.
Instead, she’s tucked away in a nondescript warehouse not too far from Hong Kong, in the city of Shenzhen, inspecting a high quality Hermès bag, alleged to be a “factory overrun” from an exclusive Hermès atelier who has a “special relationship” with the Shenzhen retailer.
Chong, an experienced bag shopper and socialite knows better than to lap up this tripe.
Odds are that this particular Hermès bag may be made from the same high-grade luxury materials as one sitting in a boutique, but it is highly doubtful if the hands of a French atelier ever molested this particular product.
Nonetheless, a seasoned buyer of Hermès Birkin bags would not be able to tell the difference.
The workmanship on this “Grade A” fake if you will, is impeccable, the attention to detail and the fastidiousness with which the product was meticulously manufactured, on the border of obsessive.
Chong, the wife of a property scion from Singapore makes these “invite-only” shopping trips to the warehouse every three months or so, catching up on gossip with her socialite girlfriends and indulging in spa treatments and of course, shopping for high-end fake handbags such as the Birkin set before her today.
“Yes it may be fake, but it’s almost impossible to get the real thing, the waiting lists are too long and they need you to buy a whole bunch of useless Hermès stuff just to have the privilege to buy a Birkin.”
“Siao! (Singaporean slang for “crazy”).”
And given her social status, few question the authenticity or provenance of her luxury purchases and besides, according to Chong, most of the Birkin’s that you see are fake anyway.
All the World’s a Fake
So it seems as well in the world of cryptocurrencies as well.
In a space wrought with scandal and opacity, a recent study by Bitwise Asset Management, a San Francisco-based digital asset manager suggests that up to 95% of all reported trading in Bitcoin is “fake” or artificially created by unregulated cryptocurrency exchanges.
For anyone who’s been in the cryptocurrency space for awhile, this revelation is not new.
“Fake volume” or “fake liquidity” has been the bugbear of cryptocurrency markets for a long time.
During the early days of the initial coin offering (ICO) bubble, there was a rush to create new cryptocurrency exchanges, with many new exchanges accepting cryptocurrencies such as Bitcoin or Ethereum and in some cases accepting the digital tokens of the ICO in exchange for a listing of the ICO’s digital tokens on their exchange.
In order to lure ICOs to list their tokens on the exchange, exchange operators would need to show sufficient volume and liquidity in their existing trading to entice “hot” new ICOs to list on their exchange.
But unlike in the capital markets, listing a digital token is non-exclusive.
Say for instance if an exchange managed to get sufficient numbers of a digital token, they could unilaterally list such a token on their exchange, without seeking permission or even consulting the issuer of that digital token.
And many cryptocurrency exchanges did precisely that.
Revenge of the Robots
But in order to generate trading interest and fees, many exchanges needed to generate volume to entice retail traders as well, which they did so by using highly automated market-making bots.
A market-making bot is essentially a program which automatically stacks orders on both the buy-side and sell-side of a cryptocurrency or digital token, providing what appears to be traders with genuine orders waiting on both sides of the trade, when in fact, there may be none.
These orders mutually cancel each other out, but add to the illusion that there is a great deal of trading going on at the exchange, when in fact there may be little to none.
When cryptocurrency markets were burning white-hot towards the end of 2017 and early 2018, market-making bots were not as obvious, given that genuine trading volume was peaking, but since the slump of almost 80% in cryptocurrency prices, volume has washed out with the markets as well.
As famed investor Warren Buffett likes to say,
“Only when the tide goes out do you discover who has been swimming naked.”
Skinny dipping then must be a industry-wide pastime now it seems.
According to Bitwise Asset Management’s analysis of trading activities at 81 exchanges over four days this month, as many as 76 had suspicious trading activity — the actual market for Bitcoin may be far smaller than it may appear.
Submitting its research to the U.S. Securities and Exchange Commission (SEC), with an application to launch a Bitcoin-based exchange traded fund (ETF), the study, which was made public on Thursday, is an attempt to alleviate the SEC’s longstanding concerns that a Bitcoin ETF would leave investors exposed to fraud and market manipulation.
According to Bitwise’s head of global research, Matthew Hougan, Bitwise’s ETF would be based upon the 5% of Bitcoin trading it considers legitimate and that such trading volume would come from the 10 regulated exchanges that can verify that their trading data and customers are real.
According to Hougan, this slice of the market is well-regulated, transparent and efficient.
And while there is a growing body of research that casts doubt on just how much cryptocurrency is changing hands daily, for anyone experienced in cryptocurrency trading, again, there’s nothing new here.
Last week, research firm Crypto Integrity concluded that 88% of all trading in February this year had been inflated. The TIE, another cryptocurrency research outfit claimed on Monday that an estimated 75% of exchanges had some for of “suspicious activity” occurring on them.
Again, there’s nothing new here.
Even without the research, common sense would suggest that there just simply can’t be as much demand for Bitcoin, Ethereum or the other gamut of cryptocurrencies that do exist according to sources such as CoinMarketCap.
To begin with, the sheer number of cryptocurrency exchanges, around 200, though the actual number is difficult to determine because some shut down quietly, in a market with a market cap of only US$130 billion is not going to see significant trading volumes on most exchanges — the numbers just simply don’t add up.
So it’s completely within the realm of contemplation that a lot of the “volume” generated on these cryptocurrency exchanges are bound to be “fake.”
To Catch a Fake You Must Think Like a Fake
But it’s the methodology with which Bitwise Asset Management used to determine authenticity of trading volume that is revealing.
Bitwise created a program to look for patterns that exemplified both real and artificial trading, with patterns that indicated manufactured trading.
Of the approximately US$6 billion in reported daily volume of Bitcoin trading in March, Bitwise calculated that only US$273 million was legitimate.
According to the Bitwise report, on regulated exchanges such as Coinbase, Gemini, BitFlyer and Poloniex, trading tended to follow certain set patterns, with trading volume for instance, rising and falling at predictable times coinciding with regular business hours.
But that in and of itself is not sufficient to point a finger to scream “fake.”
For starters, many cryptocurrency traders use automated market-making algorithmic trading bots which trade off tiny spreads or inefficiencies in cryptocurrency markets 24–7, 365 days a year.
Because such bots are automated, they don’t technically sleep and automated trading programs are a regular feature and a particularly attractive selling point for cryptocurrency traders looking to generate alpha.
Unlike traditional capital markets which do sleep, automated trading programs allow traders to make money even while they sleep.
Bitwise then pointed out that smaller trades were more frequent on legitimate volume than larger ones and many were in round numbers, arguing that these patterns reflect how human traders think and act.
True, but not all traders on cryptocurrency exchanges are human, that doesn’t necessarily make the trading activity itself fake — if so, by extension, a large volume of automated algorithmic trading by high frequency trading firms on the New York Stock Exchange would also be considered “fake.”
Bitwise also pointed out to the consistent trading volume throughout the trading day, but again, if an exchange plays host to a large number of automated cryptocurrency trading bots, it’s hard to tell the difference between the trading bot of a trading firm and a purpose-built “volume generating” exchange-driven bot.
The detection of exchange-driven trading bots requires a far more subtle and nuanced approach and as always, the devil is in the details.
Many automated algorithmic cryptocurrency trading firms are able to detect fake trading volumes on cryptocurrency exchanges more readily because the bots used are very similar to the ones driven by exchanges to generate fake volume, with one major exception — trading firm bots are profit-driven, exchange-driven bots are not — they are loss minimization.
With experience and expertise, it’s relatively easy to detect the fake volume generation on many cryptocurrency exchanges and as Bitwise rightly points out, orders on such exchanges have a tendency to cancel each other out.
But what fake volume does do is undermine the prospect and possibility of genuine price discovery on cryptocurrency markets, something that seasoned cryptocurrency exchange traders cater for in their risk management practices.
As it stands, there are already substantial price discrepancies in the price of bellwether cryptocurrencies such as Bitcoin and Ethereum between different exchanges.
Couple that with the ludicrous trading volume numbers posted by some cryptocurrency exchanges, such as the US$480 million daily volume posted by CoinBene in October 2017 and it’s not difficult to see how the industry as a whole is not helped by the practice of fake volume.
But I do understand why cryptocurrency exchanges do it.
Just as celebrities or rising stars are known to purchase followers on various social media platforms to increase their standing, upstart cryptocurrency exchanges need to attract traders to their exchanges one way or another and fake trading volume is one of them.
And while arguably the purchase of fake Hermès handbags does little to dampen the demand for the genuine product as well, fake cryptocurrency trading volume will only alienate retail investors from the “scary” world of cryptocurrencies even more.
According to Bitwise, one of the reasons that unregulated exchanges inflate trading volume is to garner a higher ranking on data services such as CoinMarketCap and leverage that ranking to require higher listing fees from digital token companies — but as the ICO market has all but dried up, it’s hard to see the rationale for that anymore.
Ultimately, fake exchange volume will be its own undoing as cryptocurrency exchanges in their current guise will likely see greater consolidation. As traders tend to gravitate towards platforms with genuine trading counterparties, upstart cryptocurrency exchanges will likely diminish and fall by the wayside.
Which is ironic given that the ethos of the blockchain was the pursuit of decentralization, greater regulation will actually see greater consolidation in cryptocurrency trading.
The same way that the capital markets are highly regulated and centralized, non-decentralized cryptocurrency exchanges are likely headed in the same direction, until perhaps decentralized exchanges rise to meet that challenge.
But that as they say, is perhaps a story for another day.
Patrick is an innovative entrepreneur and a lawyer passionate about cryptocurrencies and the business world. He is the CEO of Novum Global Technologies, a cryptocurrency quantitative trading firm. He understands the business concerns of founders and business people helping them to utilise the legal framework to structure their companies to take advantage of emerging technologies such as the blockchain in order to reach greater heights. His passion for travel, marketing and brand building has led him across careers and continents. He read law at the National University of Singapore and graduated with Honors in the Upper Division and joined one of Singapore’s top law firms, Allen & Gledhill where he was called to the Singapore Bar as an Advocate & Solicitor in 2005. He created Purer Skin, a skincare and inner beauty company which melds the traditional wisdom of ancient Asian ingredients such as Bird's Nest with modern technology. In 2010, his partner and himself successfully raised $589,000 from the National Research Foundation of Singapore under the Prime Minister’s Office. He has played a key role in the growth of Purer Skin from 11 retail points in Singapore to over 755 retail points in Singapore and 2 overseas in less than a year. He taught himself graphic design, coding, website design and video editing to create the Purer Skin brand and finished his training at a leading Digital Media Company.
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