This is How Crypto Market Data Providers "Deflate" Fake Trading Volumes
Several research studies have suggested that fake trading volumes are rampant in the crypto markets. Trading volume inflation is reportedly a much more common occurrence than previously believed, which has made it challenging for market data providers to deliver accurate data.
In this article, we will discuss the measures that leading crypto market data providers have taken to deal with the issue.
CoinMarketCap has emerged as the market-leading cryptoasset price data provider since its launch in 2013. Despite its somewhat questionable reputation - due to inaccurate market data and having run ads for fraudulent crypto companies - CoinMarketCap remains the go-to-market data platform for the majority of crypto investors.
On November 11, CoinMarketCap announced a new metric on its platform that it calls ‘Liquidity.’ The idea behind the new metric is to combat volume inflation (i.e., fake trading volumes) and to give a clearer picture of how liquid a cryptoasset actually is.
The ‘Liquidity’ metric takes a number of variables into account to determine how easy or difficult it is to trade in and out of an asset, such as the distance of the order from the mid-price, the size of the order, and the relative liquidity of the market pair in question. The weightage for each variable is determined by the role it plays in determining liquidity, according to the company. The ‘Liquidity’ metric covers both single trading pairs and exchanges.
Additionally, CoinMarketCap has responded to the washing trading issue by adjusting its volume metric. The crypto data provider excludes trading pairs in their cryptoasset volume computation for which exchanges offer fee rebates or similar potentially volume-inflating incentives.
Cryptoasset data aggregator, CoinGecko, revealed on May 13, 2019 that it was introducing a new ranking algorithm that would be used to rate both cryptocurrency trading platforms and the digital assets they supported.
The algorithm - named “Trust Score” - was implemented specifically to target the problem of wash trading and fake trading volumes, which the company believes had become rampant.
CoinGecko’s Trust Score is an algorithm whose formula considers many of the different metrics which come together to create an effective and efficient cryptocurrency trading platform. Some of the metrics taken into account include exchanges’ reported trading volume, web traffic, and order book depth.
It is important to note that CoinGecko does not employ the data provided by the exchanges, with regard to trading volumes, in its algorithm. Instead, the data provider utilizes publicly available web traffic statistics. This data is generally made available through third-party services.
Using web traffic statistics, CoinGecko calculates its own Average Daily User Trading Volume per exchange. It then uses this more subjective number to compute the Normalized Exchange Total Trading Volume (NETTV). The NETTV is then compared to the trading volume provided by the exchange.
If the numbers do not match, then the exchange is penalized in CoinGecko’s rankings. The aggregator believes this is better for the health of the market stating: “The idea here is to not rely on a single source of data, but rather multiple sources of data which will serve as a deterrent against cheating.”
On June 14 2019, cryptocurrency data provider CryptoCompare published a report explaining its new ranking methodology for cryptocurrency trading platforms. The new procedure was informed by the somewhat consistent doctoring of trading volumes witnessed in the market. CryptoCompare said: “A growing body of research suggested that a substantial group of exchanges were inflating volumes by wash trading and implementing incentivised trading schemes in order to gain status.”
The new methodology developed by CryptoCompare is called the Exchange Benchmark. The Exchange Benchmark combines both qualitative and quantitative metrics to rank exchanges in CryptoCompare’s periodical trading platform grading.
The qualitative portion of the methodology refers to the due diligence undertaken by the platform while the quantitative metric deals with the quality of the market created by the platform. The market quality is assessed based on both the trades and the order book. It is important to note that CryptoCompare deliberately eschews the use of volume in the ranking process.
CoinPaprika provides its users with “Reported Volume” as well as its own “Adjusted Volume.” “Adjust Volume” includes only trading volume from spot markets that come with a percentage commission on each trade. Markets with no fees, transaction mining or other trading incentives are excluded from this metric.
To gain further insight into actual trading activity, CoinPaprika also provides a metric called “Reported Volume Liquidity,” which illustrates the trading volume reported by exchanges and real liquidity based on their order books.
Messari has responded to the fake trading volume issue by creating a “Real 10 Volume” list that only includes the trading volumes of vetted crypto exchanges.
The “Real 10” include Binance, Bitfinex, BitFlyer, Bitstamp, Bittrex, Coinbase Pro, Gemini, itBit, Kraken, and Poloniex. To calculate the trading volumes for its listed cryptoassets, Messari only uses the trading activity from these ten trading platforms.
Additionally, Messari launched a "Liquid Market Cap" metric that uses the platform’s volume-weighted prices and “Liquid Supply” estimates. The analytics company believes that “this more accurately reflects the outstanding network value of top cryptoassets.”
Crypto market data is becoming more reliable
The lack of a global regulatory framework has resulted in unsavoury behaviour at a number of unregulated exchanges that want to appear bigger than they really are. In light of an increasingly competitive crypto exchange market, it is unlikely that wash trading and other volume inflation measures will disappear entirely.
However, market data providers are aware of this issue and aim to improve their product offering to provide traders and investors with better insight into the real state of the cryptoasset market.