What is Wash Trading in NFTs and How do you Identify One

2022-05-10, 09:47

Wash Trading is another form of Insider trading because an investor sells a commodity to himself. He may also sell it at a loss, then buy the same amount of commodity from the same place and resell it at a profit within a very short period of time. With this, a supposed illusion is created that trading volume for that commodity has increased.

Coming down to NFTs, Wash trading is a way of making an NFT appear more valuable than the underlying demand. It works in a form when someone performs multiple buys and sells of an NFT back and forth to themselves to increase the price and then finally puts it out for a sell when it has grown a lot in price; an ignorant person sees the NFT in the marketplace and thinks this is a valuable NFT due to the market volume and price displayed by the platform as a result of multiple transactions. He buys the NFT at a high price while the person who offers for sale gets a better profit and leaves the new buyer with an indeed less valuable NFT. According to research by Chainalysis, Most wash trading is unsuccessful, but a considerable level of profits is usually accrued when successful.

Source: Chainalysis

What is Wash Trading In NFT

Wash Trading in NFTs is a Process whereby the seller of an NFT conducts several transactions with himself, i.e., both buying and selling simultaneously, to present a false or deceptive impression of the NFT's Liquidity and Worth. Through this activity, the trading volume of the NFT increases with the floor price at other times. This goal is usually to make the NFT appear much more valuable than it is.

How it works and How to Identify One

Most NFT Platforms are decentralized P2P platforms for NFT transactions. Users can trade by creating a wallet and connecting directly to the platforms. Since users do not require KYC verification before trading on an NFT marketplace, A user can create multiple wallets and link to the same NFT Marketplace to partake on both ends of an NFT transaction.

This individual uses different wallets to buy and sell the exact NFT several times, automatically increasing the trading volume of the asset. As a result of these trade implementations, the underlying asset appears to be in high demand.

Identifying wash trading in NFTs requires skills such as Blockchain analysis; with this, we can trace a wash trade by looking at sales of NFTs to the self-- funded addresses. That is to say; they were either funded by the selling address or by the address that originally funded the selling address.

Examples of Wash Trading In NFTs

A remarkable example of NFT wash trading is CryptoPunk, an NFT project that Larva Labs launched. The activity took place in October 2021 when Cryptopunk 9998 was sold for 124,467 ETH (Over $532Million) within a number of hours between 3 wallets on the Ethereum Blockchain.

Source: www.ultcube88.com

Bloomberg reported on April 5, 2022, that statistics from NFT tracker CryptoSlam revealed that wash trading accounted for $18 billion, or 95% of overall trade volume on the NFT marketplace LooksRare.

Legal and other Implications of Wash Trading in NFTs

According to the SEC, Wash trading in the traditional financial markets is Illegal and seen as a means of money laundering and tax evasion. But in cryptocurrency and NFTs, the legality of wash trading is still yet established.

Even though some governments frown at cryptocurrency and NFT wash trading, the decentralized nature of NFT platforms poses a significant challenge to law enforcement in apprehending those involved in the act. However, according to Chainalysis, Wash trading in NFTs can create an unfair market for individuals who buy artificially inflated tokens, and its existence can erode trust in the ecosystem, limiting future growth.

They also confirmed that in the NFT Ecosystem, 262 users had sold an NFT more than 25 times to a self-financed address. The majority of NFT wash traders have lost money, but the successful NFT wash traders have made so much money that this group of 262 has 110 individuals who made an $8.9 Million Profit overall.

It is also believed that NFT wash trading is primarily used as a means of money laundering and also sponsors several illegal cybercrimes in the NFT world.

Source: Chainalysis

How to Prevent Falling for NFT Wash Trading Scam

The best approach to prevent purchasing NFTs with a notional value of fake worth is to buy them from a reliable source. A step further could be taken by making a blockchain analysis on the wallet addresses that fund or are tied to the NFT you wish to possess.

With the rise of Cybercrime in the NFT ecosystem, NFT platforms must take measures to sanction and discourage such practices. It would also be of great benefit if Anti-fraud laws were strictly enforced to prevent miscreants from frustrating creative investors and the trust secured by the platforms.

Author: Gate.io Researcher M. Olatunji
Disclaimer:
* This article represents only the views of the observers and does not constitute any investment suggestions.
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