Wash Trading And Sybil Attacks Are A Big Problem For Crypto Traders

The crypto industry is often described as the "Wild West" due to the lack of regulation, the insane speculation and the seemingly endless prevalence of scams and hacks, but these are not the only dangers that lurk. 

It's believed that incidents of wash trading and sybil attacks have become rampant in the crypto industry, with malicious actors taking advantage of its decentralized nature to engage in price manipulation. Though these attacks don't directly target any particular victims, they can put honest traders at a significant disadvantage.  

A recent report by the crypto research outfit Solidus Labs highlighted the enormous scope of wash trading in the crypto industry. In the 2023 Crypto Market Manipulation Report, Solidus said more than 20,000 digital assets have been manipulated through wash trading on decentralized exchange platforms in the last three years. It looked at a sample of 30,000 DEX liquidity pools hosted on the Ethereum blockchain, and found evidence of wash trading being executed in 70% of them. The aggregate value of those liquidity pools was worth more than $2 billion. 

Market Manipulation

Wash trading is a common form of market manipulation that has found a particularly welcoming environment in the crypto industry. It refers to the practice of an individual or entity repeatedly buying and selling the same asset – in effect, trading with itself. In doing this, it creates a false impression of a highly liquid market with much higher trading volumes, when in reality the trade does not reflect any change in ownership of the affected asset. 

Some traders engage in wash trading in order to artificially inflate the price of a crypto asset. To outsiders, it looks as if the market is vibrant and numerous trades are taking place. This attracts greater interest in the asset and pushes up the price. Traders who engage in wash trading do it so they can sell large volumes of tokens at the inflated price. Honest traders may perceive the artificial volume created by wash trading as a buy signal, and pay over-the-odds for the asset. 

Concrete data on the occurrence of sybil attacks is more elusive, but a simple Google search reveals no end of headlines that refer to this type of malicious activity. Sybil attacks are where a person or entity, or even a group, attempts to gain a disproportionate level of control over a blockchain network or DeFi protocol by creating multiple nodes at low costs. By controlling a majority of network nodes, malicious actors gain additional voting power to influence decisions taken by the project's community, and can influence the value of an asset in this way. 

Avoiding sybil attacks is a big problem for certain blockchain networks. To confirm transactions, nodes must vote to approve or reject each block. But if the network relies on a simple "one node, one vote" system, bad actors can create multiple nodes and achieve unfair influence over this process. They can then give preference to their own trades and manipulate the market to gain a profit at the expense of others. 

Wash trading and sybil attacks can form the basis of bigger scams, for example a rug pull, which is where the creators of a token simply disappear with the takings from their initial token sale. The project is, in effect, non-existent. Once the rug pull occurs, investors are left holding worthless tokens. Through wash trading and sybil attacks, the scammers can artificially inflate the token price to maximize their profits. 

Why Are Crypto Markets At Risk?

Wash trading doesn't only occur in crypto, but also in traditional financial markets. However, the practice has found fertile ground in the crypto industry, where decentralization and the lack of regulation makes it far easier to perform. Moreover, in crypto, liquidity is highly fragmented across hundreds of exchange platforms, resulting in much smaller markets that can easily be manipulated. Traditional finance, in contrast, is highly regulated, and there is less fragmentation of liquidity, meaning wash trading is more difficult to pull off successfully. 

Evidence of this comes from a 2022 National Bureau of Economic Research study, which found that more than 70% of unregulated exchange volumes were wash trades

Sybil attacks are not specific to blockchain networks either. For instance, the infamous case of Russia influencing the 2016 U.S. election that saw Donald Trump voted in as President was performed using Sybil-like tactics on Facebook and Twitter. Russian agents created thousands of multiple identities on those networks to post and share "fake news" to try and manipulate the vote. That said, just as with wash trading, sybil attacks are an extremely useful tactic for anyone wanting to manipulate crypto markets

Mitigating The Risk 

Due to the lack of regulation, crypto exchange platforms are under no compulsion to try and detect or prevent wash trading or sybil attacks, and so crypto traders need to be on their guard. 

To ensure a trading experience that's free of manipulation, traders are advised to select a platform that is committed to preventing these kinds of attacks. One such platform is ApeX Pro, which is a DEX platform focused on enabling precision trades within the decentralized derivatives market. To safeguard trading for its users, ApeX Pro has teamed up with the crypto analytics firm X-explore to identify and eliminate wash trading and sybil attacks on its platform. 

X-explore identifies wash trading through a careful analysis of transaction times, volumes, prizes, sizes and more. Should a trading account trigger any alarms, it will automatically be classified as a wash trading account and flagged to prevent it from engaging in any further malicious activity. 

A different strategy is employed to identify and prevent sybil attacks. It involves collecting data from the Etherscan blockchain explorer and transforming this into a graph that can be processed more easily at rapid speed. X-explore uses a graph neural network that's trained on the topography of this graph to generate an embedding for each node address. Then, by cross-referencing these embeddings with data on transaction values, times and gas fees, it can identify any signs of clustering that are indicative of a sybil attack. 

Using these strategies, ApeX Pro is uniquely able to protect its clients and instill confidence that the trading volumes and numbers on its platform are accurate, reflecting the reality of the market. 

Given the difficulty of identifying and preventing wash trading and sybil attacks, they have become a critical problem for the crypto industry. Thankfully, awareness of this problem is growing and more exchanges are taking steps to prevent such activities, mitigating the risk of their users being manipulated and paying over the odds.