Comprehensive coverage

The crypto boomerang - the National Science Foundation

To attract traders, crypto exchanges artificially inflate their activity volume. does it work?

Hundreds of crypto exchanges offer traders the opportunity to buy and sell decentralized assets, such as the currencies Bitcoin, Ethereum, Solana, and more. But unlike "normal" exchanges - the crypto exchanges are not supervised.

"There is no real regulation in the crypto market at this point, so the competition is a wild west," says Prof. Yevgeny Leanders, head of the Hogge Institute for Applied Blockchain Research at Tel Aviv University. "The exchanges try to attract potential traders in every possible way, and one of the common ways is called 'simulated trading'. Since the trader looks first at the trading volume, these exchanges have a mechanism that artificially increases the trading volume: simply open two virtual wallets and transfer coins from side to side to increase the volume of activity."

Evaluation of real (right) and simulated (left) trading in crypto exchanges
Evaluation of real (right) and simulated (left) trading in crypto exchanges

This phenomenon of simulated trading in crypto exchanges is a common and well-known phenomenon, which has been studied in both academia and industry. In fact, Prof. Leanders and his colleagues estimate that about 20% of all crypto trading is virtual trading.

"We wanted to check - with the help of a research grant from the National Science Foundation - the relationship between the amount of simulated trading in a given exchange and certain currencies, and indices of competition between the exchanges," says Prof. Leanders. "After all, the greater the competition, the more the incentives to artificially inflate the trade also increase. The most obvious measure of competition is the number of exchanges that trade in two different currencies, for example Bitcoin and Solana. If there are ten exchanges that offer to exchange buy and sell bitcoins in Solana and vice versa, the trader of these currencies will prefer to trade on the largest exchange, because it is likely to be the most liquid - and therefore the exchange has an interest in displaying a larger volume of activity. And indeed, we found a close relationship between the competition for each currency pair and the volume of simulated trading. When such a measure of competition increases by one standard deviation, we found that the volume of simulated trading increases by 30% to 40% of its standard deviation."

Of course, artificially inflating the trading volume through dummy transactions does not actually generate traders who will seek to buy and sell the currencies on the other side. That's why traders are tempted to trade on an exchange that inflates its trade, but soon realize that there aren't that many traders on the other side - so they pay more transaction costs.

"After we found a close connection between the competition for each currency pair and the simulated trading in each exchange, we checked whether this strategy is profitable for the exchanges", says Prof. Leanders. "Unsurprisingly, we found that it was very profitable in the short term - meaning that the simulated trading did attract potential traders and therefore also created actual trading. But in the long run, the traders preferred to stay away from that exchange, as it did not meet their price expectations - which, as mentioned, stemmed from that simulated trading. Of course, this phenomenon is not unique to the crypto exchange, and it aligns with economic theories of optimal choice from other fields: those who sell a product that is less good than the product on display will profit in the short term, but in the long term, the demand for their product will suffer."

Life itself:

"I like South American literature," says Prof. Leanders. . "Borges, Cortser, Marx and more. And skiing and basketball. A large part of my work is done at night, while watching basketball games."

Skip to content