Surreal image of crypto coins in a washing machine, representing wash trading in the crypto market.

Crypto Wash Trading: Unnecessary Treatment or Essential Regulation?

Lena Voss in Business & Economy December 2025 • 4 min read.

"Explore the debate around wash trading in crypto assets: Is it being overtreated, and what does liquidity have to do with it?"

Liquidity is the lifeblood of any asset market, and the crypto space is no exception. When an asset lacks liquidity, it can lead to wider bid-ask spreads, increased transaction costs, and potential price volatility, making it harder for investors to trade efficiently. Ironically, too much unregulated liquidity can also be a problem, leading to price jumps and market manipulation, requiring careful analysis to model the return with well behaved autoregressive properties. In either case, it is important to treat wash-trading to improve the assets responsiveness to the autoregressive models.

One of the practices that can artificially inflate liquidity metrics is 'wash trading.' This involves a trader simultaneously buying and selling the same asset to create misleading trading volumes and potentially influence the price. The question then becomes, how do we effectively identify and treat wash trading to ensure a healthier market?

Recent research sheds new light on this issue. One study suggests that treating wash trading might not always be necessary for established crypto assets traded on mainstream exchanges. Instead, focusing on liquidity adjustments may be a more effective approach to modeling asset behavior and mitigating the impact of manipulative practices.

Liquidity Jump vs. Liquidity Diffusion: What’s the Difference?

Surreal image of crypto coins in a washing machine, representing wash trading in the crypto market.

To understand this perspective, it's essential to differentiate between two key components of liquidity: liquidity jump and liquidity diffusion. Liquidity jump refers to the magnitude of sudden spikes in liquidity, often driven by large trades or market events. Liquidity diffusion, on the other hand, reflects the volatility and dispersion of liquidity over time, indicating how smoothly assets can be traded throughout the day.

The study indicates that liquidity diffusion has a stronger correlation with crypto wash trading than liquidity jump. This suggests that wash trading activities are more likely to impact the consistency and stability of liquidity rather than causing dramatic, isolated spikes. This nuance is critical in determining the appropriate course of action.

Liquidity Jump: Sudden, large spikes in trading volume.
Liquidity Diffusion: Consistency and stability of trading volume over time.

Therefore, treatment of wash trading is believed to reduce the volatility of liquidity diffusion by removing the intraday volatility of the daily liquidity, but does not reduce the magnitude of liquidity jump. These measures have to be carefully defined, to help combat extreme liquidity, and restore the return and volatility of assets with extreme liquidity.

The Bottom Line: A More Nuanced Approach to Crypto Regulation

While wash trading is undoubtedly a concern in the crypto market, this research suggests that a one-size-fits-all treatment approach may be overly restrictive. For established crypto assets on major exchanges, focusing on liquidity adjustment strategies might be a more effective way to model asset behavior and protect investors. By understanding the distinct impacts of liquidity jump and liquidity diffusion, regulators and exchanges can develop more targeted and efficient measures to ensure a fair and stable market.

About this Article -

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Everything You Need To Know

What is 'wash trading' in the context of crypto assets, and why is it a concern?

In the crypto asset context, 'wash trading' involves a trader simultaneously buying and selling the same asset. This creates artificial trading volumes which can mislead investors and potentially manipulate the price of the asset. It is a concern because it undermines the integrity of the market, giving a false impression of demand and liquidity.

How does liquidity affect the functionality of crypto asset markets, and what are the potential downsides of unregulated liquidity?

Liquidity is crucial for crypto asset markets because it ensures efficient trading. When an asset has good liquidity, bid-ask spreads are tighter, transaction costs are lower, and price volatility is reduced, making it easier for investors to trade. However, unregulated liquidity can also cause problems like price jumps and market manipulation. This means that the market requires mechanisms that improve the responsiveness to autoregressive models.

What is the difference between 'liquidity jump' and 'liquidity diffusion,' and how do they relate to the impact of wash trading?

'Liquidity jump' refers to the magnitude of sudden spikes in liquidity, often driven by large trades or market events. 'Liquidity diffusion' reflects the volatility and dispersion of liquidity over time, indicating how smoothly assets can be traded. Research suggests that wash trading has a stronger correlation with liquidity diffusion, implying that it affects the consistency and stability of liquidity more than causing dramatic, isolated spikes.

Should the treatment of wash trading be applied uniformly across all crypto assets, or should the approach be more nuanced? Why?

A one-size-fits-all approach to the treatment of wash trading may be overly restrictive. For established crypto assets on major exchanges, a more nuanced approach, such as focusing on liquidity adjustment strategies, might be more effective. This is because wash trading's impact can vary, and strategies that target liquidity diffusion may be more appropriate than broad restrictions, helping to model asset behavior and protect investors effectively. This approach acknowledges the distinct impacts of liquidity jump and liquidity diffusion.

What are the implications of focusing on liquidity adjustments instead of directly treating wash trading for established crypto assets?

Focusing on liquidity adjustments, rather than direct treatment of wash trading, implies a shift towards modeling asset behavior and mitigating the impact of manipulative practices indirectly. This approach acknowledges that not all instances of wash trading require the same level of intervention and that maintaining stable liquidity diffusion may be more crucial for market health. However, it also suggests that regulators and exchanges must develop targeted measures to ensure a fair and stable market, understanding that liquidity jump events might still warrant specific attention.