DeFi players lambaste report that market is riddled with $2bn in wash trades

In the last three years, decentralised exchanges permitted the wash-trading of at least $2 billion of cryptocurrencies, says Solidus Labs, a crypto research firm.

Solidus called the finding a “major DeFi market integrity challenge.”

But those working in the industry have challenged Solidus’ findings.

They say the report unfairly conflates dodgy pools with mainstream ones, and doesn’t provide a clear picture of DeFi trading overall.

Wash trade debate

The debate was touched off by a report Solidus published last week. It found that liquidity providers on Ethereum-based decentralised exchanges — or DEXs — wash-traded the prices and volumes of more than 20,000 tokens since 2020.

Solidus said it used 30,000 DEX liquidity pools in its sample, and that “wash-trading has constituted 13% of the pools’ trading volumes.”

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Wash trading is a form of market manipulation in which an entity repeatedly buys and sells the same asset to pump up its trading volume and mislead the market.

But some DeFi experts say Solidus’ report cherry picks the pools it looked at to draw a general conclusion of widespread wash-trading.

“While the study seems to uncover genuine wash-trading in long-tail assets, the results are far from generalizable to DEXs more broadly,” Nagaking, a Curve Finance grantee who studies DeFi market structure, told DL News.

‘Wash-trading is not a profitable strategy for the large majority of tokens.’

—  Nagaking

With so much of DeFi trading directed by sophisticated players, using an old market trick may not even pay off.

“Wash-trading is not a profitable strategy for the large majority of tokens, whose DEX volume tends to be dominated by arbitrage and directional betting,” he said.

Cherry-picked data

Other critics have raised concerns about the report’s data sampling.

“The in-sample contains only cherry-picked malicious tokens, a.k.a. scams,” Mikko Ohtamaa, CEO of DeFi trading protocol Trading Strategy, said in response to Solidus’ report. “It does not represent DEXs or trading pairs overall.”

A Solidus representative said the report “clearly states the research is based on a meaningful sample, not on the entire DEX ecosystem.”

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“Our sample did not contain only scam tokens,” Solidus told DL News. “Nearly half of wash-trading volume detected in our research came from liquidity pools of benign and legitimate tokens.”

Yet the methodology set out in Solidus’ report throws this assertion into question.

The research firm said it only included data on pools where the first liquidity provider provided more than 90% of both tokens in the pool at all times during trading.

Liquidity pools

But liquidity pools for scam tokens are almost always funded by a single, large liquidity provider, and typically receive little to no liquidity from outside sources.

A recent example of a token where its creator provided the vast majority of liquidity was BALD on Coinbase’s Base chain. It cost investors over $5.2 million dollars after its creator pulled the rug on the token.

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Such a set up also excludes the biggest and most frequently used liquidity pools, such as Curve Finance’s 3pool, where liquidity providers are more evenly distributed. 3pool has facilitated more than $288 billion worth of trades since its launch in January 2020.

Additionally, Solidus said it only analysed liquidity pools if either one of the tokens in the pool contained malicious code, or in cases where the pool facilitated more than two trades for every unique trader using it. This approach further excluded legitimate tokens.

Targeted attacks

Critics say there is a good reason why activity surrounding such tokens shouldn’t be lumped in with all DeFi trading. Ohtamaa told DL News that because of the permissionless nature of public blockchains, anyone can easily create tokens and generate volume on DEXs at very little cost.

This makes launching such tokens a low-risk way for scammers to lure victims in targeted attacks, Ohtamaa said. But the practice doesn’t significantly interfere with mainstream DeFi trading of well-established assets.

“They just clutter up datasets, never seen by real users or traders,” Ohtamaa said. “It takes more than deploying a token trading pair and generating some volume to make people buy into a scam.”

DL News asked Solidus about the limitations of its sampling criteria but did not receive an immediate response.

Real market abuse

However, Solidus highlighted what it said was one particular wash-traded token in its dataset — SHIBAFARM — as an example of a scam with real victims. The SHIBAFARM token is what’s known as a honeypot — a token that lets traders buy it, but is coded to never let them sell.

“We saw real testimonies from individuals hurt by this market abuse,” Solidus said, linking to a TikTok video of one investor who said he lost eight Ether, valued at around $30,000, by buying SHIBAFARM.

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While apparent scams are not uncommon, Ohtamaa argued such activity pales in comparison to legitimate trading.

“We estimate far less than one percent of real user trading volume on DEXes to be associated with scams,” he said.

“If you exclude spammers and liquidity sniping bot operators,” he added.

Have a tip on DeFi? Contact the author at tim@dlnews.com.