As the NFT ecosystem becomes more sophisticated, so do the scammers operating in the blockchain space. Wash trading is a well known type of market manipulation that also happens to be perfectly suited to the FOMO of the NFT space. But this damaging practice is damaging both to individuals and the space as a whole. This article gives you the lowdown on wash trading, so you can avoid being scammed yourself.
Defining NFT Wash Trading
NFT wash trading is a type of scam. Wash trading is a misleading act to drive up the price of NFTs by the buyer and seller. The buyer and seller can sell the piece back and forth to drive up the cost, but only publicly report the first sale. In the next exchange, the money and NFT are returned to the original seller at the same time. Most of the time, the buyer and seller are the same bad actor.
When the asset is sold, it goes to a new cryptocurrency wallet that the original owner also controls. NFTs are easy to link with the trading platform because users simply connect their wallets — sometimes without needing to identify themselves.
The price of NFTs then increases because future buyers feel it is in demand with all the sales. Cryptocurrency is valued the same way — by demand.
Blockchain analysis is one way to check the sale of NFTs to look for those that are self-financed for wash trading.
Why do people engage in NFT Wash Trading?
There are different motives as to why some people are engaging in NFT wash trading. Here are the two main motives behind this act.
1. To earn platform rewards
Some NFT marketplaces reward active users by giving them returns (in the form of the protocol’s token) based on their trading volume. Wash traders take advantage of this and maximize their rewards by generating unrealistically large amounts of trading volume. In turn, this can easily deceive users who want to analyze NFT collections or marketplaces in terms of liquidity and volume.
2. To create an appearance of value or liquidity
To create a false sense of liquidity and an inflated value of a specific NFT collection or asset, some unscrupulous creators turn to wash trading to deceive buyers. They profit when genuine buyers are tricked into buying an NFT from them at a pumped-up price. This type of wash trader hides their activities with new wallet addresses that are self-funded from central exchange wallets. This type of wash trading generates a relatively small volume, which is not as disruptive to the market as the first type of wash trading provided above.
How to spot an NFT wash trade
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 NFT 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.
Final Thoughts
Without proper regulatory oversight and enforcement, NFT wash trading is an unavoidable phenomenon on NFT marketplaces. Traditionally, manipulating prices/volumes and fraudulently harvesting tax losses are illegal, and that standard is likely to hold for crypto. Wash trading to farm token rewards, on the other hand, is a new type of activity unique to crypto.
While the primary victims at risk are the marketplaces themselves, unsuspecting users may also be harmed during this activity. Although there are ethical concerns, crypto natives would argue that code is the law. If the NFT marketplaces have not imposed any limitations on reward distributions, why shouldn’t users take advantage of this bug feature?
