As the cryptocurrency markets begin to heat up again in advance of 2024’s Bitcoin halving and expected ETF approval, we can expect DeFi innovation and activity to resume once again. After all, it was the “DeFi summer” of 2020 that preceded the last bull market in 2021, and DeFi is generally the only sector that offers potential returns in excess of the generous gains posted by flagship crypto assets like Bitcoin and Ethereum.
However, wherever liquidity flows, it’s invariably followed by the type of people who would seek to drain it away through practices like wash trading and Sybil attacks. As well as knowing how to spot these tactics, users should also know about measures that projects such as ApeX and Hop Protocol are taking to banish such practices from their own operations.
What is Wash Trading in DeFi?
Wash trading refers to the practice of artificially inflating trading volumes with false trades to create an impression of healthy market activity. Either the same person is buying and selling the same assets, or two parties may collude.
Wash trading is illegal in most markets. However, due to the historically unregulated status of crypto, it became a problem initially on centralized exchanges and subsequently in DeFi. Often, it can be carried out by bad-faith token issuers attempting a rug pull. However, traders attempting to top exchange activity leaderboards may also be incentivized to try wash trading.
The “2023 Crypto Market Manipulation Report” published by Solidus Labs found that liquidity providers on Ethereum-based DEXs had wash traded around $2 billion of crypto, covering over 20,000 tokens. Furthermore, Solidus stated that this is a conservative estimate based on the sample data it used for the report. In NFTs, the problem could be even worse, with some estimates from users of Dune Analytics suggesting that 80-90% or more of activity on some platforms is wash trading.
What are Sybil Attacks in DeFi?
Sybil attacks are a type of attack on decentralized systems where a single entity is able to pose as many by creating multiple false accounts. In the context of a public blockchain, creating more than one account is relatively easy since users are pseudonymous. However, it’s only when someone does this with malicious intent, such as to influence governance decisions or incentives, that it’s classed as an attack.
In September 2023, one individual was found to have generated over 21,000 Sybil wallets, its own token, and an entire DEX to simulate on-chain activity. It was suspected that these activities were in preparation for scamming legitimate airdrops – a common motivation for launching Sybil attacks. However, Sybil tactics may also facilitate wash trading when a user creates multiple addresses to give the impression of being more than one entity.
Rooting Out Wash Trading and Sybil Attacks
Wash trading can be very difficult for the average user to spot, particularly if they are newer to the cryptocurrency sector, but there are some helpful signs. In DeFi, wash trading tends to focus on low liquidity assets, like small-cap tokens or lesser-known NFT collections, which benefit from a false perception of demand.
Using a blockchain explorer, you can check transactions to make sure that there is a decent variety of transaction addresses being used for any given asset rather than the same addresses over and over. Abnormal patterns in trading volumes can also indicate malpractice, such as sudden price spikes or periodical volume reductions that cannot be explained.
However, the unfortunate reality is that much wash trading goes unnoticed by most traders, who will assume transactions are in good faith. ApeX is one example of a platform that takes this good faith seriously by taking clear steps to prevent wash trading and Sybil attacks on its Layer 2 order book DEX.
ApeX has partnered with X-explore, which uses on-chain risk analytics to detect unusual activity based on defined triggers. Using a solution like X-explore allows ApeX to process the huge volumes of data generated by trading activity on its high-speed platform to root out fraudulent trading activity, giving users more peace of mind.
ApeX’s focus on user experience also extends to its trading bot offering, which is integrated with Telegram for ease of use. However, like the ApeX exchange, the bot is self-custodial, meaning user funds are never at risk.
Crowdsourcing Sybil Identification
ApeX’s behind-the-scenes approach to fighting Sybil attacks with X-explore makes for an uninterrupted user experience. Still, another project took a more novel approach to the concept of “Sybil Hunting.” When cross-chain bridge Hop Protocol launched its airdrop, one of the steps it took was to invite its community to submit Sybil addresses. If they passed a verification check to determine them as such, the “hunter” received additional token rewards, with some managing to rake in thousands of dollars worth of rewards.
Wash trading, and Sybil attacks are risks that DeFi users should be aware of and try to avoid. However, rather than becoming a blockchain sleuth, an easier option is to head for platforms and services that take these threats – and their own reputations – seriously enough to try and address the problems at the source.
