As the cryptocurrency world continues to grow and develop, there have come both substantial new technologies and opportunities as well as strategies for cheating or gaming the system. In recent weeks, investigations have probed the possibility of price manipulation among some of the largest digital currencies in the world. Now, a report by Bitcoin.com suggests that there may be other types of manipulation occurring as well; cryptocurrency exchange operators can artificially inflate trading volumes thanks to a "backdoor ICO" strategy that is receiving criticism.
Trading and Mining
For digital currency exchanges, trade volumes have always been key figures. Without substantial volumes, these exchanges have a difficult time growing their customer base. For many in the crypto community, high trade volume is the single most important marker of a successful exchange. There are many ways that an exchange can incentivize increased trade volumes, including zero-fee transactions and similar offers. Some of these strategies have even veered toward the illegal, as accusations have flown that some exchanges have hired market makers to constantly trade, effectively doubling the true trade volume because they take part in both sides of the transaction.
The latest strategy for increasing trade volumes may be even more problematic, though. Some exchanges have reportedly begun to pay traders to use their platforms. Known as "transaction fee mining," this model is designed to incentivize trades by offering users a token particular to the exchange as a "reward" for trading. This is not a new strategy in the wider investment world; it mirrors cashbacks and other incentives seen in the FX and stock trading worlds. However, the fact that digital tokens used as incentives by exchanges are themselves dividend-bearing securities makes the process a complicated one.
Exchanges like Fcoin, Coinbene in Singapore and Bit-Z in Hong Kong have all employed this model to supplement their user base and trade volumes, all with some degree of success. This has been particularly irksome to Binance, the major exchange which has its own token for distribution through an ICO. Binance CEO Changpeng Zhao disparaged the model on social media, saying that "if an exchange's survival depends largely on the price rise of its own token rather than on transaction fee earnings, it has to drive up the token price. In this regard, less experienced traders and retail investors can hardly have the upper hand in the trading competition with those crypto whales, especially the exchange whale."
Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns bitcoin and ripple.