The shadowy practice is often used to manipulate markets and create a false sense of high demand. The non-fungible token (NFT) market saw explosive growth in 2021, with traders investing tens of billions of dollars worth of cryptocurrency into digital collectibles.
Sales of digital artwork like Beeple’s Everydays. The 2020 collection also moved major money into the space and record high sales of rare Bored Ape Yacht Club NFTs highlighted an increase in momentum and demand for NFT projects.
NFT transaction activity has since cooled, according to blockchain data firm Chainalysis, though the number of active NFT buyers and sellers continues to grow in 2022.
While the popularity of certain NFT projects can fluctuate depending on market conditions, some traders may try to manipulate the prices of certain NFTs to make them appear more valuable through a process called wash trading. Here’s everything you need to know.
What is NFT wash trading?
Wash trading is when the buyer and seller in a transaction are the same person or two people colluding. It’s banned in conventional financial markets because it misleads the rest of the market about the true level of demand, distorts prices and entices others to trade on fake information.
This activity has been illegal in many traditional markets in the U.S. since the passage of the Commodity Exchange Act (CEA) of 1936.
However, the practice still occurs in unregulated crypto markets, and in particular with NFTs. According to Chainalysis, “Wash trading involving NFTs has yet to be the subject of an enforcement action.”
Historically, wash trading has been an issue for cryptocurrency exchanges attempting to inflate their trade volumes – for example, Bitwise Asset Management claimed in 2019 that up to 95% of all reported bitcoin (BTC) trading volume on exchanges is faked.
With NFTs, an individual might set up multiple crypto wallet addresses to buy and sell an NFT to themself to make it appear as though a digital asset is highly valuable.
Transactions between wallet addresses are stored on a blockchain and can be viewed publicly – meaning, anyone can see when an NFT was traded and how much that NFT sold for. However, wallet addresses contain no identifying information and are presented as a string of alphanumeric characters, making it very difficult to discern who is behind a transaction and if two wallet addresses are owned by the same individual.
Examples of NFT wash trades
While wash trades are often hard to detect, there have been notable examples of inflated NFT trades that were used to manipulate market prices. On Oct. 28, 2021, CryptoPunk 9998 was traded between two wallets for 124,457 ether (ETH), worth around $532 million at the time. The sale of the white-haired, green-eyed, pixelated character was picked up by CryptoPunks Bot, which automatically tracks and announces CryptoPunks transactions on Twitter.
According to Etherscan, the buyer used a flash loan from multiple sources to pay 124,457 ETH to the CryptoPunk’s smart contract, which was then transferred to the seller’s wallet. The seller then sent the 124,457 ETH back to the buyer, who repaid the loans – a sign of a suspicious transaction.
Ultimately, the CryptoPunks team tweeted that the transaction was null, and that “in a nutshell, someone bought this punk from themself with borrowed money and repaid the loan in the same transaction.”
At the end of the wash trade, the NFT was listed back on the market for 250,000 ETH, or about $1 billion. To put things in perspective, this particular CryptoPunk was selling for between $300,000 and $400,000 before the wash trading incident.
Some NFT marketplaces have also been accused of fostering an environment for wash trading. For example, data compiled by NFT tracker CryptoSlam suggests that $18 billion of the trading volume on LooksRare, or about 95% of the total activity, has been linked to wash trading.
How to spot an NFT wash trade
In February 2022, Chainalysis published a report on NFT wash trading by analyzing sales of NFTs to addresses that were self-financed, or “funded either by the selling address or by the address that initially funded the selling address.” It concluded that “some NFT sellers have conducted hundreds of wash trades.”
In particular, it was able to identify 262 users who had sold an NFT to a self-financed wallet more than 25 times. Although Chainalysis admitted that it could not be 100% sure that all of the users were NFT wash traders, 110 of those wallets collectively generated $8.9 million in profit in 2021.
“[The] $8.9 million is most likely derived from sales to unsuspecting buyers who believe the NFT they’re purchasing has been growing in value, sold from one distinct collector to another,” the report said.
Still, it noted that most NFT wash traders it identified have not been profitable – meaning, their profit did not make up for the gas fees they spent on each Ethereum blockchain transaction.
It’s worth noting that the profit made from wash trading is likely higher since the report only considered transactions made in ether and wrapped ether (wETH).
If you’re interested in buying an NFT, here are some possible signs of wash trading to look out for:
Price: If the NFT you’re looking to buy is priced significantly higher than the collection’s floor price (the lowest price an NFT is selling for in a particular collection), then it is possible the NFT has been wash-traded, especially if that NFT has little to no rare attributes that might explain a higher price point.
Transaction history: Tools like Etherscan and BscScan can be used to check the transaction history of an NFT. Some marketplaces, like OpenSea, also display this information on their listing pages. A sudden jump in the price of an NFT without any prior activity could be a sign of wash trading.
Previous owners: Look out for wallet addresses that show up multiple times in the transaction history, as in the case of CryptoPunk 9998. If the same wallet has purchased an NFT multiple times, then it could be a sign of wash trading. You can also look at individual wallet addresses to see if they’ve interacted with other wallet addresses listed in an NFTs transaction history – another potential sign that the wallets may be closely linked to one another.
Wash trading is an illegal practice in most traditional markets in the U.S., although it remains difficult to enforce in the crypto space because of the pseudonymous nature of blockchain interactions.
NFT traders will engage in this activity to create a false impression of high demand and inflate the value of an NFT collection.
Typically, there are signs to look out for when an NFT has been wash traded, such as a major difference between the floor price and list price of an NFT in a collection. Ultimately, researching an NFT collection and looking at the transaction history is important to understanding if an NFT’s price has been manipulated.
August 23, 2022 Published by CoinDesk.