What is wash trading?
Crypto for Professionals
A form of market manipulation in which investors create artificial activity in the marketplace by simultaneously selling and buying the same cryptocurrencies.
When an investor buys and sells the same security investment at the same time, this is known as wash trading. The IRS calls this a wash sale since purchasing the same security cancels out the sale of that security. Because you're effectively ending where you started — with shares of the same security in your portfolio — it's also known as round-trip trading. Market manipulation can be accomplished through wash transactions. In order to affect price or trading activity, investors can buy and sell the same securities. The purpose could be to stimulate purchasing in order to raise prices or to encourage selling in order to lower prices. Investors and brokers may collaborate to affect trading volume, usually for both parties' financial gain. For example, the broker may profit from commissions collected from other investors who want to buy a stock that is being targeted for wash trading. Price manipulation, on the other hand, may result in gains for the investor through the selling of securities. Wash trading is a type of insider trading in which the persons engaged have access to information about a security that the general public does not have. Insider information might be used by an investor or broker to perform wash trades.
A wash trade, on the surface, is when an investor buys and sells shares of the same security at the same time. The definition of wash transactions, on the other hand, goes a step further and considers the investor's (and maybe the broker's) intent. In order for a wash trade to exist, there are two conditions that must be met:
- Intent: at least one of the parties must enter the trade specifically for that reason.
- Result: the result should be wash trade – bought and sold the same asset at the same time.
Beneficial ownership refers to accounts held by the same person or company. Financial regulators may be interested in trades made between accounts with common beneficial ownership since they could indicate wash trading activity. The level of risk transmitted to the investor is a clear measure of wash trading activity. A trade could be termed a wash if it does not change their overall market position in the security or expose them to any form of market risk.
Wash trades, on the other hand, don't always have to involve actual trades. They can also occur when investors and traders pretend to conduct a trade on paper, but no assets are traded.
Wash trading is prohibited by the Commodity Exchange Act. Traders utilized wash trading to manipulate markets and stock prices before the Act was passed. Wash trading is also regulated by the Commodity Futures Trade Commission (CFTC), which includes standards prohibiting brokers from benefitting from wash trade activity.
When it comes to wash trading, the IRS has its own set of restrictions. The laws prevent investors from deducting capital losses from sales or transactions of stocks or other securities that result in a wash sale from their taxes.