Wash Trading is at its peak

Token not exchangeable

Before we begin, let’s quickly review the issues related to this technology. To put it simply and in summary, an NFT is not interchangeable, and like all works of art, they are not created equal. Each NFT is different because unique, each has a digital certificate registered on a blockchain. Furthermore, by relying on blockchain technology, they benefit from its unique characteristics, namely its traceability and tamper-resistant aspect. Simply put, anyone on the internet can share a photo of a famous painting, that doesn’t mean they own it. The signature helps to show that you are the sole owner and again thanks to the blockchain, everyone can see that the NFT belongs to you. For example: a copy of the famous Mona Lisa painting is not very valuable. What makes the painting valuable is actually 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”.

Trading washed in 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.

“Spoof trading is a process by which a trader buys and sells a security with the express purpose of providing misleading information to the market. In some situations, wash transactions are executed by a dealer and broker cooperating, and other times wash transactions are executed by investors acting as buyers and sellers of the security.” Investopedia.

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

In the context of NFTs, “wash trades”, ie. transactions where the buyer and seller of an NFT are identical or in collusion are much more prevalent in the market than thought. This allows cheaters create an illusion of liquidity and manipulate market value. A manipulation that results in investors being attracted to a falsely traded asset and therefore being swept into the immutable sauce with an asset that has been artificially inflated. In other words, the end buyer thinks they are getting a good deal by buying an NFT, sometimes for several thousand dollars, when in reality it is worth nothing and no one wants it.

Wash marketers participate 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 wallets belonging to the same owner.
  • Collect rewards 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 to make it look like there is more activity than there is organically. Counterfeit trading can be used to stimulate demand for a financial asset or to hide money from illegal activities, for example.

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

2022: the explosion of NFT Wash Trading

In the graph below, you will visualize the proportion of organic transactions in light gray (which can be described as genuine, real transactions) compared to that associated with black wash trading (market manipulation).

Washing trade
Dune Analytics

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

NFT volumes

Nansen

The most popular markets such as OpenSea, LooksRare or even X2Y2 have announced that they are implementing monitoring and reporting measures to limit wash trading. But looking at what actually happened in 2022, it wasn’t a huge success. Regulation is another important solution, and it will probably come at some point in the future, but no one knows when. The problem is that this regulation probably won’t apply in all jurisdictions, and we know that many malicious actors either ignore it or find a way to circumvent these regulations anyway.

At the moment, in order to avoid “force washing”, it is necessary to validate the addresses on the blockchain to identify if the asset in question is transmitted at different prices, but to similar addresses. A relatively long process that will probably discourage a large number of investors from checking whether the asset they adore will destroy them or not.

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

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