Competition and Product Quality: Fake Trading on Crypto Exchanges
72 Pages Posted: 12 Jan 2021 Last revised: 15 Mar 2021
Date Written: March 14, 2020
How competition affects product quality and how product quality choices impact firms' operating performance are open empirical questions. We use a setting that is especially suitable to answering these questions: cryptographic exchanges, on which product quality is inversely related to fake (inflated) trading volume. We examine the effects of competition among crypto exchanges on their trading volume inflation and the impact of fake trading on exchanges' operating performance. We develop statistical measures to detect fake trading, which we validate in several ways and use in analyzing determinants and consequences of trading volume inflation. Various static and dynamic competition measures are positively associated with measures of fake trading at both the exchange and exchange-currency pair levels. Exchanges that inflate trading volume tend to succeed in misleading investors in the short run but are punished in the long run, consistent with the tradeoff between short-lived increases in rents and future losses due to damaged reputation.
Keywords: Crypto exchanges, fake trading, competition, product quality, reputation
JEL Classification: G23, L13
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