If two people bought and sold the same widget for $10 a million times, that would be neither a wash trade, nor much more informative than one person buying and selling a widget for $10, right? But the trading volume metric would look the same as if millions of people were buying and selling.
Strangely this isn't in fact true. It feels like it should be, but just because something has been consistent historically is not evidence that that's going to continue into the future.
That's not relevant, though - except in the most trivial way of the problem of induction[0]. Technically, we can't be sure the sun will rise tomorrow, or that gravity will still work the same way 5 minutes from now. Neither can we be sure the market will not collapse next week. But this way lies madness - reasoning about the future is impossible. Fortunately, experience consistently demonstrates that if we have a good model of something, reality tends to stick to it, so we can use it to predict things.
With nihilism out of the way, how is million people independently trading a thing for $10 once meaningfully different than a single buyer/seller pair trading a thing for $10 a million times?
A price of an item isn't a random phenomenon - it's just a reflection of what buyer and seller believe other people would pay for that item. This belief is based mostly on knowledge of what other people actually paid for it (or a similar widget) in the past. This process is mostly convergent[1]. Prices change at the rate of information flow, and tend toward some equilibrium. The process may be quite unpredictable, but the expectations are bounded.
As a result, markets automatically price everything relative to everything else, in a way that mostly makes sense. This is a very useful property - it's a bottom-up, implicit, somewhat fair way of solving resource allocation problem in society.
Generating fake trades like this? It's injecting bad data into the market. It's poisoning the mechanism of price determination - which, to produce reasonably fair determinations, needs aggregate trades to average great many distinct buyer/seller negotiations. Amplifying a single datum with fake trades ultimately makes the market worse at efficient resource allocation, and thus less useful to society. It's pissing in the pool from which everyone drinks.
> A price of an item isn't a random phenomenon - it's just a reflection of what buyer and seller believe other people would pay for that item. This belief is based mostly on knowledge of what other people actually paid for it (or a similar widget) in the past.
It's even more helpful than that. It shows that a million people valued widgets at $10 or more, and a million others valued them at $10 or less. So if you value it at $10, you won't be too wrong.
With some assumptions about liquidity and the depth of pocket of market makers, you can draw some further conclusions like "not many people could have valued it at $12 or more".
> how is million people independently trading a thing for $10 once meaningfully different than a single buyer/seller pair trading a thing for $10 a million times?
> Generating fake trades like this? It's injecting bad data into the market. It's poisoning the mechanism of price determination - which, to produce reasonably fair determinations, needs aggregate trades to average great many distinct buyer/seller negotiations. Amplifying a single datum with fake trades ultimately makes the market worse at efficient resource allocation...
I'm not a legal or markets scholar, so please excuse this possibly dumb question.
Why are wash trades specifically harmful, as opposed to book orders that don't self-trade?
Like, I think what Coinbase did not get in trouble for here was having a large order book that they did not intend to trade (spoofing), but they instead got in trouble for trading with themselves at prices they would have traded with any other market participant. (Seemingly, as a fluke of the way they structured their market-making apparatus as two separate bots, instead of a single bot.) Since this was on a public market, the trades inherently happened somewhere between the public bid and ask prices -- right? I don't understand how the self-trades manipulate the price information. The fakeness that comes out of this seems to be purely the metric of trading volume.
If I'm wrong, please let me know! I'd love to learn more. Thanks.
> just because something has been consistent historically is not evidence that that's going to continue into the future
The technical term is precedent transactions. Less technically, more observations of a thing increases confidence that the thing exists.
It does not guarantee that the thing will continue to exist. But then again, nothing does. (We “know” the sun will rise tomorrow because it rose yesterday and the day before that.)
I feel like it's 100% accurate to say 1,000,000 transactions within the last week gives you more confidence than 1 transaction within the last week as to the current market price.
It's not a statement about the future, it's about the present. You should indeed be more confident that 10 is the right price right now if you see a load of people near you in time and space trading at 10.
1- It makes an exchange appear more liquid than competitors, even though it isn't, which gives it an advantage. Customers are tricked into signing up to what they believe is a liquid exchange. It's false advertising.
2- It could trick customers into executing larger trades than what the liquidity is capable of handling without price impact, but this is a more minor point to the above.
You could spoof a large order book without ever wash-trading with yourself (this is not legal advice). The specific regulation is around self-trades. If there is a lot of orders around $99.98 and $100.02 you can be pretty confident something is worth about $100 even if it never trades.
The liquidity is not there. You might be enticed to buy litecoin since you can be sure to be able sell it anytime without much slippage and then be surprised that there are no buyers.
They weren't spoofing the order book, right? You would look not just at trade volume, but also the bid interest, when considering future liquidity, I think. And that information was all accurate, to my knowledge. (I might be totally wrong! Would love to learn more.)
In addition to screwing with price discovery, it also inflates Coinbase Pro’s volumes and makes the exchange look like a better place to trade. Crypto exchanges are often ranked/judged by their volumes.
What’s bad about that? (not concern trolling, just a noob)