Wash trading is a type of market manipulation designed to feed misleading information to the market.
The Long Explanation
The practice of ‘wash trading’ began in the stock market but has since found its way into the crypto market as well. While there are a few different ways of going about it, the objective is always the same: misleading the market to believe there’s real interest in an asset when that isn’t the case.
In some cases, the process involves a couple of traders who collude to simultaneously buy and sell very similar amounts of the same cryptocurrencies in order to create artificial activity around it. This artificial activity gives the impression that the market accepts the new price point, although that is false.
Wash trading may also be an automated process that involves the use of bots. These bots create and execute large trade volumes of both buy and sell orders of similar amounts in a short time period. Eventually, the buy/sell orders cancel themselves out, but (potentially) trigger the market into activity.
This pattern of trading could be instituted by investors, traders, brokers, or exchanges alike. Young exchanges may use wash trading to create the appearance of large market activity on their exchange, which should, in turn, encourage other traders to use their platform.
For exchanges, wash trading may involve them directly trading on their platform as though they were regular platform users. It could also be a case of fabricating the order books to make it look loaded with trading activity.
Whichever the case, wash trading is illegal in the stock market and frowned upon in the crypto market.