Wash trading in nonfungible tokens (NFT) is back in the spotlight. After critics claimed that Blur, a fast-growing NFT marketplace, has incentivized this practice with its trading rewards scheme,

Blur’s token supply totaled 10% which was distributed to its users based upon their trading activity under its second token reward program, starting February 14. This platform has experienced a significant increase in trading volume compared to other NFT marketplaces.

Skeptics believe that wash trading was a major factor. CryptoSlam reports that around $577 million worth NFTs were traded back-and-forth in recent months, and that 80% are “inorganic.” But opinions differ.

Hildobby’s new Dune Analytics deep dive argues that most of the platform’s trading volume is above board because of how it has structured its rewards. However, the analysis does not give a clear picture of the sector’s health. The same methodology suggests that LooksRare (95%) and X2Y2 (285%) have suspicious volumes.

NFT markets have been responsible for $73.8 billion in trading volume. Dune Analytics data shows that 42% of volume is fake. $31.2 billion was attributed to wash trading.

These effects can have wide-ranging consequences. Collateral damage has been caused by the inexperienced digital collectors who have become victims of inflated prices and the manufactured popularity of some collections. In some cases, criminals used NFTs to launder money.

However, there is good news for educated collectors in that most wash trade surrounds the types of NFT collections preferred by inexperienced collectors.

“While there is certainly a lot of wash-trading in absolute terms, it is mostly happening to NFT collections that have a poor reputation.”

What is NFT Wash Trading?

Wash trading isn’t a new concept. This term is not new. It originated in the early 1900s. In the United States, wash trading was practiced by selling securities before the end of the tax year in order to claim a loss and then purchasing them back.

Artist’s impression of a typical wash trading scenario. (Pexels)

The practice of wash trading in crypto is an offshoot from those early practices. This involves individuals or groups buying and selling a financial asset to create the illusion of greater trading volumes or liquidity. It is done primarily by exchanges and projects to be more popular.

Important to know that wash trading is illegal in many jurisdictions and is strictly prohibited by major regulatory agencies. The practice, which is considered a form market manipulation, is dangerous to investors and a threat to financial markets’ integrity.

Regulators are still trying to understand the intricacies of the cryptocurrency market, which is still relatively new. NFT and crypto wash trading are left in a grey area that is not regulated and controlled. In the upcoming budget, however, President Joe Biden proposes closing the loophole which made it legal for crypto assets to be traded in the U.S.

Analyst research and industry experts providing insights to Cointelegraph Magazine suggest that wash trading continues across many NFT marketplaces.

NFT Wash Trading and Money Laundering

Hildebert Moulie, one of these experts, is the one who brought NFT washing trading to the forefront in late 2022. Moulie works as a data scientist for Dragonfly, a cryptocurrency investment company. Moulie also built a data dashboard to help remove the mystery surrounding wash trading in NFT.

In a popular Dune post, he found that wash trading accounted for around 80% of NFT trading volume in January 2022. This figure was approximately 58% for all of 2022. Moulie used four filters to route out wash trading.

First, addresses that identified both the buyer or seller of a particular NFT were flagged. The second filter identified trades that occurred between two wallets. It was also possible to wash trade if an address purchased the same NFT more than three times. This filter is used to identify addresses and trades that bypass the above-mentioned filters by verifying that the seller and buyer addresses were funded from the same wallet.

Moulie’s data shows that 42% of NFT trading volume today is driven by wash trading across 29 NFT marketplaces.

Chainalysis, a blockchain analytics company, also explored NFT wash trading in two separate reports for 2022. One of the key findings from Chainalysis’s research was that 110 profitable wash traders netted $8.9million in profits last year. Magazine is told by the company that while government agencies are interested in NFT wash trading, they have declined to give any details.

Chainalysis monitors illicit funds that move through the cryptocurrency ecosystem. Its tools detected an increase in illicit funds flowing to NFT markets in the last two quarters of 2018, with $2.4 million being sent towards the end of 2021.

Chainalysis monitored $8.6 billion of cryptocurrency-based money laundering in 2021. The report concluded that illicit funds sent to NFT markets for money laundering pale in comparison. However, cybercriminals have the option to use this practice.

Money laundering via NFT wash trading is only a very small slice of the issue (Chainalysis))

Which NFT market has the lowest wash trading?

Moulie’s research identifies LooksRare as the worst and X2Y2 is the best. 94.7% and 85% respectively of LooksRare trading volumes are allegedly attributable to wash trading. This is significant considering that both platforms have processed $27.6 million and $4.2 billion respectively in trading volume.

OpenSea is still the largest NFT marketplace in volume but has a better track record with only 2.35% of $33.1 billion in trading volume attributable to it.

Blur (14%), Sudoswap (1%), Skillet (17%), and BitKeep (12.8%), all have wash trading rates in the teens, while NFT aggregator Element has NFT aggregator Element with the third highest wash trading percentage at 63% of its $94.3million trading volume.

DappRadar shares data from Cointelegraph which corroborates Moulie’s insights. From January 2022 to March 20,23, LooksRare had 20,743 NFTs that were likely wash trade sales. X2Y2 had 11,289.

OpenSea had 4,357 NFTs flagged for possible wash trade sales. Blur produced 2,285 in the four-month period.

DappRadar data showed that the ratio of likely wash volume to total volume on LooksRare is 3,361.96%. X2Y2 had a ratio of 210.99%.

Data from DappRadar supplied to Magazine breaks down NFT wash trade sales numbers by marketplace. (DappRadar)

NFT Wash Trading, explained

Moulie tells Magazine NFT wash trading is when NFTs are traded between addresses owned by the same person with the aim of merging into organic trading.

This type of activity is primarily driven by two reasons. Trading platforms such as LooksRare or X2YX reward traders with token rewards. If done correctly, traders can make a profit trading NFTs by purchasing token rewards to offset their fees.

This second reason is subversive. A trader may try to make a NFT collection appear larger in order to attract more traders and higher bids.

“Wash trading, if not detected, could increase the perceived value an NFT collection to other traders. This may lead them to buy/trade it.”

Moulie, however, believes that it is impossible to sustainably replicate organic trading over a prolonged period of time. He also notes that any collection revealed to have been heavily washed will be unattractive for potential collectors.

Zhong Yang Chan is the head of research at CoinGecko. He agrees that the intention is to manipulate trading volumes, NFT prices, and tax loss harvesting.

He claims that NFT washing trading has eroded some trust and credibility in markets and also played an important role in the NFT bubble in 2021 by allowing projects and participants to play “numbers only goes up”.

Also read



Features

How much enforcement can you do to clean up crypto?



Features

Why Animism gives Japanese Characters a head start on the Blockchain

Chan believes wash trading is a threat to the ability to prove NFT ownership. This is what Chan believes will make collections more valuable and distinguish them from other physical and virtual collectibles. This results in collections that are subject to price distortions and wild fluctuations.

While this doesn’t affect NFT authenticity it can impact the perceived value of an NFT collection and make doubts about its ability to build a strong community.

Andrew Thurman is an analyst at Nansen’s blockchain analytics platform Nansen. He echoes Moulie’s sentiments and points out the scams associated with wash trading and its negative impact on real users.

Scammers could make a lot of money by washing trade low-volume collections. Thurman cites Nansen’s research that found instances where scammers created and washed trading collections in order to persuade users to mint new NFTs.

Scammers alter the mint price in the middle of the mint or force users to trade against them to earn trading fees, or to sell useless NFTs.

These NFTs have no organic value, but are made to appear briefly as if they do.

Thurman also points out that wash trading can also have a negative impact on NFT marketplaces and platforms users, since it reduces the rewards organic users would receive.

How to stop NFT wash trading

How can industry counter wash trading?

Moulie points out that there are many approaches to wash trading in NFT markets. Fees are a major factor. Wash traders are unable to maximize their profits due to the additional costs of trading.

Marketplace fees and creator royalty are two fee mechanisms that take a percentage of trader’s profits. Moulie highlights OpenSea as one example. Other marketplaces copied the platform’s royalty fees.

Moulie suggests that another way to curb the practice is to eliminate the types of incentives that encourage trading.

Blur has a new solution. Instead of trading tokens that are being airdropped to users like LooksRare or X2Y2, it rewards listings.

Chan also points out that there is no regulation or apparent enforcement of NFT markets. Traditional financial assets are not allowed to be manipulated or tax loss harvested. As Biden’s budget proposals indicate, regulators will enforce this law in the future. It might not be easy to apply the existing standards in the new Web3 or NFT space.

Pedro Herrera, DappRadar’s head of research, notes that NFT washing is becoming a growing concern for regulators around the globe. However they have larger fish to fry.

He says that crypto adoption, DeFi, and security tokens are the regulatory areas of focus. “It is crucial to establish rules for the Web3-based financial layers.”

Thurman told Magazine that trading throttles have been introduced by platforms like Blur and OpenSea as preventative measures. The trading throttles prevent an NFT being listed if it has recently changed its address, but do not eliminate the practice.

He says, “Aside from this, it is difficult to prevent wash trading on platforms such as LooksRare or Blur – it’s part of the sybil issue.”

Also read



Features

NFTs don’t have to make you mad



Features

Can Crypto be Sweden’s Saviour?

Sybil attacks are a threat to decentralized networks and blockchain in particular. An attacker seeks to control or influence a system by creating and controlling large numbers of pseudonymous addresses, wallets, or identities.

Thurman suggests that Sybil attacks on NFT marketplaces could allow an attacker create fake trading volumes for various NFTs using a variety of addresses they anonymously control.

Wash trading is not covered by NFT data providers

Wash trading, in addition to the obvious effects of artificially increasing prices and astroturfing popularity is also a distortion of the ability analyze and monitor cryptocurrency markets. Moulie said that before he could provide detailed insights on NFT trading, it was necessary to eliminate wash trading activity in order to understand what was really going on.

“Any good analyst will tell ya that the first step in studying a data set is to clean it up,” he said, noting that many NFT data providers filter for wash trading activity.

He says that many of the top analytics platforms use wash trading filters. The industry secrets behind how they are constructed are often kept a secret.

Thurman shares Nansen’s NFT Trends & Indexes section, as an example. He also uses the wash trading filter. The first image shows NFT trading volumes in the marketplace with wash trading disabled.

Nansen data with wash trading removed (Nansen)

The second screenshot shows wash trading. It highlights market distortions caused by platforms that reward trading volume. With the wash trading filter off, LooksRare and Blur can trade between 10-20 times more volume than LooksRare.

Nansen data with wash trading pumping up the volume (Nansen)

Chan claims that analytics platforms are becoming more adept at identifying and filtering wash trading. This activity is reflected in specific transaction patterns that allow algorithms to distinguish disingenuous trades and genuine transactions.

“Wash traders are getting more sophisticated. Analytics platforms are also improving their algorithms in order to detect new patterns in wash trading.”

Thurman says that even with all their best efforts, wash trading still distorts analytic insights to a certain extent.

How to identify NFT Wash Trading

One key point is that NFT traders and collectors need to be aware about wash trading and its effects on prices and volumes of collectibles and collections. Thurman states that “Actual collectors need to be aware of classic scam vectors.”

Vlad Hategan is a cryptocurrency expert at dappGambl and shares useful tips for identifying potential NFT washing trading.

Research is the first port of call. Research the market for an artist or artwork. Potential red flags include sudden spikes in price or trading volume. Patterns that appear out of the norm, such as spikes in trading volume or persistently low trading volumes for a long period of time, are indicators of manipulative trading. You may find help with wash trading dashboardson Dune.

Avoid platforms that permit anonymous users to trade NFTs.

Another sign that a wash trading scheme is in place to attract unwitting traders is the low or discounted price.

If you are unsure, get help. Good guidance can be provided by traders and financial advisers who are familiar with NFT markets to spot suspicious-looking NFTs.

Gareth Jenkinson

Gareth is a radio journalist and presenter from Durban, South Africa. He’s not talking on radio about sport, but he has his eyes on the cryptocurrency market.