Well, folks, the cat’s out of the bag when it comes to crypto’s fake volume problem–recently (as you may or may not know), Bitwise Asset Management presented a controversial report to the SEC as part of their application process to create a Bitcoin exchange-traded fund (ETF.)
In the report, Bitwise told the SEC that 95 percent of all trading volume in the Bitcoin market is fake. The firm seemed to say that its ETF would be immune to market manipulation because it knew exactly when, where, and how it was happening.
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But the presence of fake volume in the cryptosphere isn’t just a problem for companies who want to create crypto-based investment products.
Recently, Finance Magnates spoke with Nir Dovrat and Alon Karniel, who are (respectively) the CEO and COO of Algoz. Algoz is the crypto-focused subsect of the Fingenom Group, an Israel-based conglomerate of algorithmic trading companies.
Because Algoz works primarily with liquidity in the crypto trading space, Karniel and Dovrat were able to share their expertise on what the plague of fake trading volume means for the crypto industry. We also learned about the work their company does along the way.
Algoz, the Crypto Arm of Fingenom Group, Was Born Out of the Need for Better Liquidity in the Cryptosphere
“Fingenom Group is a group of algo (algorithmic) trading companies, which means that we develop algorithms that have the ability to trade in the traditional markets,” Dovrat explained. “Each company in the functional group has a different strategy, but we all work together for a common goal, and we all use the same infrastructure, so whenever one company has an improvement to the infrastructure we all benefit from it.”
“Algoz started as the market-making company of the Fingenom group. We do market-making in traditional markets in Europe, Israel, and other places in the world,” Dovrat said.
The company’s involvement in crypto began as “kind of a hobby” around two years ago, he explained. “We invested in ICOs.”
It was this dabbling that eventually led to an important revelation–“we realized that there is a huge problem with liquidity in [the cryptosphere],” Dovrat continued. As a result, “we decided to see if we can solve it all or assist in any way using our algorithms.” Eventually, crypto became the company’s main focus.
The work that “In the traditional world we do market making for our own profits,” Dovrat explained. However, in the crypto world, “we are not focused on ‘how can I make money off the traders’; we are focused on how we can increase liquidity and make it possible for traders to trade against us and enjoy it, and [to have] good prices–not only what is the best price for [us] to profit, but what is the best price for us to contribute to the project ecosystem.”
Once the company entered into the cryptosphere, Karniel says that word spread quickly. “We managed to work with more than 50 clients in 2018; [we were] integrated to more than 20 exchanges [and became] official market-makers in some of those exchanges.” The company has since begun to offer other products and services, including an OTC trading desk.
Will the SEC Approve Bitwise’ Bitcoin ETF Application?
Because Algoz works extensively with liquidity in the crypto world, both Karniel and Dovrat have become intimately acquainted with the ins-and-outs of crypto liquidity, including the elephant in the room: crypto’s fake volume problem. The crypto industry was shocked at its revelations.
What was shocking to Dovrat and Karniel was not what the report revealed, but rather that the fake volume issue wasn’t already widely known. Karniel saw Bitwise’ use of a kind of ‘reverse-psychology’ to win the SEC over as an interesting strategy–but he doesn’t believe that Bitwise’ attempt to seek permission to create a Bitcoin ETF will be successful.
“It’s a nice strategy, but I don’t see [how] from a regulator’s point of view how a regulator can look at a market which someone is saying is 95 percent fake and say, ‘well ok–just because you said it’s 95 percent fake, I’m now approving an ETF on that’..I would be surprised if this will be accepted. But this is a good step–this and the Bitcoin Transparency Institute report as well. We need to remove all those fake volumes from the market.”
“Until a substantial part of trades will not be [fake] trades, and people will not be afraid of trading on fake-volume exchanges,” it will be very difficult for regulators to permit something like a Bitcoin ETF.
“What a regulator needs to do is to protect the day-to-day trader. They’re not here to protect the big institutions–Kraken or Binance or whichever exchange it is. They need to protect the simple trader who wants to go in and purchase a Bitcoin, and to know that he purchases and asset that will not fall by 20 percent the next day because of fake trades.”
“Although it’s a nice and maybe refreshing approach, I don’t see it as a something that the SEC will say, ‘ok, we can live with that because you told us what the truth is.’”
Average Traders Need to Care About Fake Volume in Crypto–Or Face Serious Consequences
But fake volume isn’t just a problem for large institutional firms who are trying to create Bitcoin ETFs. Karniel and Dovrat explained that fake volume isn’t just a problem that affects large players in the crypto industry–it can also have serious implications for startup projects and individual traders.
For example, “if you purchase an token in an ICO, and now the project is going for listing into an exchange (which, you know, takes for the listing for $1 million to $3 million for listing [fees]) and it is shown that there is a large volume on the exchange when in fact, there is no volume in this exchange,” Dovrat said.
So, fake volume can do massive damage to projects who are seeking an exchange with high trading volume. “The project spent three million dollars–which should have been used for development or marketing other stuff which is legit and which is necessary for the project–on listing to an exchange on which there is no real volume. Then, the traders cannot trade and cannot have an exit or entry strategy, so it can hurt you [as the trader],” Karniel said.
Fake trading volume can also falsely drive up the prices of crypto assets. “A lot of this wash trading is done by the exchanges themselves, which means that an exchange might be trading against its traders,” Karniel explained. “This means that a trader can enter into a trade which is of a fair price, because the exchange is trading against him.”
“I want to invest $1 million, I want to make sure that I can sell $1 million in the exchanges.”
Dovrat said that fake volumes can also be harmful to investors because of the way that it creates misleading expectations for liquidity. “If I’m an investor looking to invest in a crypto project…one of the most important things is that if I want to invest $1 million, I want to make sure that I can sell $1 million in the exchanges.”
If an investor sees fake trading volume that he or she thinks is real–for example, $10 million in trading volume–and wants to invest $1 million, that investor “would expect to have an easy exit strategy,” Dovrat continued. The investor would think, “I can exit whenever I want. [The exchange has] a daily volume of $10 million and I need to sell only $1 million.” A non-professional trader could accomplish this over a few days.
“But if all this volume is fake–and I just bought $1 million and the real volume is $5,000 per day, now I have a huge problem,” Dovrat said.
Detecting Fake Volume
So, the consequences of taking an exchange’s reported at face value can be absolutely disastrous. However, it may come as a surprise that there are some rather simple techniques for detecting whether or not an exchange is faking its volume.
“What I personally do is that I never trust the volumes that I see–never, no matter what exchange I am using,” he said.
The first method for detecting fake volume involves attempting an experimental trade. “First of all, take a look at the order book. If you see huge volume, but the quantities in the top layers–the relevant layers of the order book are really small,” something’s up. Ask yourself: “how can the volume be so high but no one stands in the relevant places?”
“The second thing you can do is just drop a small order of $100 in one of the relevant places (in the first buy or the first sell) and see what happens–if someone takes [you] or not.”
“In many cases, you will see that no one takes you for hours, and you [remain in the first position the whole time.] So, this is suspicious… this is when I usually believe that the volume is not real.”
This is an excerpt. To hear the rest of Finance Magnates’ fascinating interview with Algoz’ Nir Dovrat and Alon Karniel, please click on the Soundcloud or Youtube links.