Wash Trading is at its peak

Non-fungible token

Before we begin, let’s quickly review the issues related to this technology. To put it simply and succinctly, an NFT is not interchangeable, and like all works of art, they are not the same. Each NFT is different because it is unique, each with a digital certificate registered on a blockchain. Moreover, by relying on blockchain technology, they take advantage of its unique features i.e. traceability and its tamper-proof appearance. Simply put, anyone online can share a photo of a famous painting, it doesn’t mean they own it. The signature helps prove that you are the sole owner and, again thanks to the blockchain, everyone can see that the NFT belongs to you. For example: a replica of the famous Mona Lisa painting is not very valuable. What makes the painting precious is precisely the consensus around Leonardo Da Vinci’s signature.

Unfortunately, despite the aforementioned characteristics, and like many other assets, market manipulation is no exception in the NFT space. In other words, many people try to manipulate the price of these digital assets through what is called “wash trading”.

Wash Trading with NFT Sauce

Wash Trading is a term used in finance, which refers to the process of buying and selling assets to create a misleading market signal.

“Dummy trading is the process by which a trader buys and sells a security for the express purpose of misleading the market. In some situations, washouts are done by a colluding trader and broker, and other times washouts are done by investors who act as both the buyer and seller of the security. Investipedia.

Of course, wash trading has been illegal in the US since the Commodity Exchange Act (CEA) of 1936, but cryptocurrencies and NFTs, being unique and recent digital assets, exist outside this framework. Wash traders have taken full advantage of this lack of regulation in the cryptocurrency and NFT space, with some even believing that wash trading accounts for the vast majority of bitcoin’s spot trading volume.

In the context of NFTs, “wash trades”, i.e. transactions in which the buyer and seller of an NFT are identical or colluding, are much more common in the market than one might think. This allows scammers create an illusion of liquidity and manipulate the underlying market value. A manipulation that results in investors being lured into a falsely traded asset and then being plucked in the non-fungible sauce with an asset that has been artificially inflated. In other words, the ultimate buyer thinks he’s getting a good deal buying an NFT, sometimes for several thousand dollars, when it’s actually worth nothing and nobody wants it.

Wash Traders participates in the following trends to manipulate the industry:

  • Buying an NFT to stimulate artificial demand for a project.
  • Artificially inflating transactions by buying and selling assets between portfolios belonging to the same owner.
  • Collect rewards by using assets that are more valuable than transaction fees.

These practices have created a dangerous and unfair environment for investors and collectors. It is a form of fictitious trading, i.e. manipulating the market by making it appear that there is more activity than there would be organically. Fictitious trading can be used, for example, to stimulate demand for a financial asset or to hide money from illicit businesses.

In the NFT market, platforms have been betting on cryptocurrency rewards for active traders to get their attention and gain market share. This situation is ideal for “wash traders”, who can simply trade NFTs between their wallets and receive cryptocurrency rewards for each transaction. It is a risk-free profit as long as the value of the prizes is greater than the transaction fee.

2022: The explosion of NFT Wash Trading

In the chart below, you will see the share of organic transactions in light gray (which could be described as genuine and real transactions) versus that associated with black wash trading (market manipulation).

Commercial washing
Dune analysis

How widespread is wash trading in the NFT world? Well we find that at its peak, in January 2022, wash trading accounted for 80% of NFT transactions. The average for the year rises to 58%. This is obviously bad news for JPEG enthusiasts. With NFTs already in a brutal bear market, with volume well below 2021 highs.

NFT volumes

nansen

Popular marketplaces such as OpenSea, LooksRare or even X2Y2 have announced that they are implementing monitoring and reporting measures to limit wash trading. But looking concretely at what happened in the year 2022, it hasn’t been a great success. Regulation is another relevant solution and will probably come in the future, but nobody knows when. The problem is that this regulation probably won’t apply in all jurisdictions and we know that many bad actors ignore it or find a way around these regulations anyway.

For now, to avoid being vigorously faded, addresses on the blockchain need to be authenticated to identify whether the asset in question is broadcast at different prices but to similar addresses. A relatively lengthy process that will likely discourage a large number of investors from checking whether or not the asset they adore will squeeze them.

To conclude on a positive note, I am personally convinced that NFT technology is very interesting and will gradually take hold in business processes. I am confident that concrete and useful use cases will emerge in the coming months/years. Meanwhile, caution remains in order on NFT markets.

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