If you have been involved in the NFT space then you have probably heard of wash trading. This malicious practice has plagued the industry by distorting the value and demand of collections.
That is why in this article, I will be covering all aspects of NFT wash trading. So without further ado, let’s jump right in.
What is NFT wash trading?
Wash trading is a market manipulation tactic used to mislead the market. The same person or multiple colluding entities artificially distort the value and liquidity to entice demand.
How does it work?
NFT wash trading works when multiple wallets buy and sell NFTs to themselves to increase the volume and price of the collection and therefore the perceived demand.
For instance, imagine a seller owns a $2 million NFT and they “sell” it to another wallet they own. The NFT is now worth $2 million based on its trade history and the overall volume (demand) has also increased.
How big of an issue is NFT wash trading?
In a nutshell, NFT wash trading is a huge issue and it will only get worse with the introduction of zero fees and royalties.
Crypto firm Chainalysis recently published a report analyzing wash trading and they found that an estimated 95% of transactions on the marketplace LooksRare were wash traded.
That being said, NFT wash trading is not profitable for the majority of individuals when taking into account gas fees. Of the 262 wash traders Chainalysis investigated, 152 were unprofitable.
Example of NFT wash trading
One notable example of NFT wash trading was the sale of CryptoPunk 9998 on October 28, 2021. It was sold for $532 million and with the average NFT being worth only a few hundred thousand this was a clear red flag.
According to EtherScan the buyer then sent the funds and the original NFT back to the seller’s wallet address in a matter of hours. It was then re-listed for over $1 billion.
Is NFT wash trading illegal?
This depends on the country. But in most jurisdictions wash trading is illegal. For instance, since 1936 the Commodity Exchange Act has prevented wash trading in the United States at the federal level.
Moreover, the European Union has proposed the Markets in Crypto assets (MiCA) law in hopes of combating wash trading.
That being said, as the NFT space is relatively new with little regulation it is difficult to determine what constitutes wash trading as well as the ability to enforce the law.
Why is wash trading so prominent in the NFT space?
Several factors lead to large amounts of NFT wash trading. Here are the following reasons:
- Extreme volatility – this incentivizes rapid buying and selling.
- Anonymity – thanks to the underlying technology of NFTs individuals can trade anonymously. This means they face little consequences for wash trading.
- Zero fees & royalties – as mentioned previously NFT marketplaces have started to introduce zero-fee trading with no royalties. As a result, there is little to no cost associated with wash trading.
How to spot NFT wash trading?
If you are browsing NFT collections it is important to watch out for wash trading. Here are several ways of spotting wash trading:
- Unrealistic amount of trading volume – the first red flag is the volume. If it is a relatively new project with a small community but a large amount of trading volume this is a warning sign. Oftentimes, scam projects artificially increase volume in hopes of getting their NFT collection on the marketplace leaderboards and distorting demand.
- Price – if the price of a specific NFT is significantly higher than the floor price and it is not in line with its rarity then this could be an indication of wash trading.
- Transaction history – thanks to blockchain technology the trade history of NFTs is completely transparent and so can be verified. If the same wallet is used multiple times then the owner has likely wash traded.
Why is NFT wash trading a problem?
NFT wash trading is a problem as it prevents the ability to make informed decisions. Key metrics which are used to determine the value of a collection are distorted.
This can lead to investors purchasing overvalued NFTs or outright scams.
If you want to view this article in a more visual format then please check out my video below:
As you can see, wash trading is a huge problem in the NFT space. It distorts value and contributes to the illegitimacy of the space.
That being said, as the industry continues to develop there will be more ways of combating it as well as regulation clarity. I hope you found this article useful and thanks for reading it.
Want to learn about 5 ways NFT projects make money? Click here to read my previous article.