The importance of liquidity for an exchange and the problem of “Wash Trading”

In general, choosing the right place for trading our goods or products is relevant, but this is particularly important for crypto assets. Even if it is possible to trade OTC, with direct deals based on case to case rules, the most popular way of buying and selling cryptocurrencies is through exchanges. Actually, there are hundreds of them, with different features. They can be centralized or decentralized, some allow dealing also with fiat currencies while others don’t, some show a large variety of exchange opportunities, some are limited to few couples, but when we choose an exchange we always have to consider also its liquidity.

What is liquidity? Liquidity is the feature of a market allowing one actor to buy or sell one or more items without changing its price in a relevant way. Like the centre of gravity in a celestial system is influenced by each body mass, even the smallest one, each market price is influenced by each trade, even the slightest. However, in a liquid market this influence is abysmal, not relevant at all. Liquidity assures that prices reflect the whole flow of offer and demand, in a stable and continuous way, and an efficient market must be liquid.

A wise investor or trader should always choose the most liquid market, able to show him the most correct price of the moment, so there is a sort of challenge between exchanges to show the higher liquidity, exhibited through the volume of trades: the highest the volume, the most liquid the market, the easiest is selling your crypto and the most correct is the price; moreover, the most difficult is the execution of improper behaviours like “Pump and Dump” . We have also other indicators of market liquidity, beside traded volume, like trade volume volatility, price volatility and order book. Unfortunately, there are often problems in giving the correct evaluation of market liquidity, especially in an environment where rules have not been precisely defined yet or are ignored: in fact, a common practice between many exchanges is the so-called “Wash Trade”.
With Wash Trade we refer to a form of market manipulation in which an investor or institution simultaneously sells and buys the same financial instrument, altering the real trade volume and creating an artificial picture of liquidity. It is not easy to detect Wash Trading, if you can’t rely on some insider, as they are able to mask it in normal trading, often using also average traders; but www.cryptoexchangeranks.com conducted a statistical investigation on seven of the largest exchanges (OKeX, KuCoin,Bittrex, Poloniex, HitBtc and HuobiPro), revealing that these exchanges present, at different levels, periodical suspect patterns which could be connected to Wash Trading.
In conclusion, liquidity is an essential feature to consider in choosing an exchange, but we have to be very careful to protect our investments from the unfair behaviours of many professional operators. To avoid problems, it is better to rely on a professional investor who can build long-lasting deals with the best actors.