Protecting the NFT Market from Wash Trading: Understanding and Detecting Manipulation in the World of Non-Fungible Tokens

    Introduction to NFTs and wash trading

    The non-fungible token (NFT) market has exploded in popularity in recent years, with NFTs being used to represent unique digital assets such as art, collectibles, and even virtual real estate. However, like any other market, the NFT market is not immune to manipulation and fraud. One tactic that has been used to manipulate the NFT market is wash trading on Ethereum, which accounted for more than half of this year’s NFT volume.


    Definition of wash trading

    But what exactly is wash trading? Wash trading involves creating multiple accounts and using them to buy and sell NFTs among themselves in order to create the illusion of active trading and demand for the NFTs, leading to inflated prices. Sometimes, traders may also use automated bots to carry out the trades in order to make it more difficult to detect the activity. The consequences of wash trading can be severe for both the NFT market as a whole and individual investors. Inflated prices can lead to significant losses for those who buy into the market at high prices, only to see the value of their NFTs plummet when the wash trading is discovered.

    Over Half of NFT Volume in 2022 Was Wash Trading
    Understanding and Detecting Manipulation in the World of Non-Fungible Tokens

    Consequences of wash trading for the NFT market and individual investors

    Wash trading is not a new concept, and it has been illegal in the United States since the passage of the Commodity Exchange Act (CEA) in 1936. However, the trade of cryptocurrencies and NFTs has largely remained unregulated, and it is expected that wash trading will eventually be subject to regulation as well. The CEA provides oversight for traditional commodities and futures, but does not currently cover the relatively new and rapidly evolving markets for cryptocurrencies and NFTs.


    History and past controversy surrounding wash trading

    Over the years, there have been numerous instances of wash trading involving fungible crypto assets on centralized exchanges (CEXes). For example, in March 2019, Bitwise presented evidence to the Securities and Exchange Commission (SEC) showing that approximately 95% of the reported $6 billion in Bitcoin spot trading volume on CoinMarketCap was fake. There have also been instances of wash trading on exchanges such as Binance, where certain trading pairs saw a sudden increase in volume after trading fees were removed.

    wash trading is a real threat to the integrity of the market
    wash trading is a real threat to the integrity of the market


    Extent of wash trading on different platforms

    The extent to which wash trading occurs varies significantly from platform to platform. Some platforms, such as NFT marketplaces like OpenSea and Foundation, have low levels of wash trading and see it as a minor contributor to their volume and transaction counts. However, other platforms, including LooksRare and X2Y2, rely heavily on wash trading for their volume and have a high proportion of wash traders among their user base. Element and Sudoswap are also known to be culprits of wash trading.


    Steps to protect against wash trading

    To protect against wash trading and ensure the integrity and fairness of the NFT market, investors can research NFTs, verify their authenticity and provenance, and look for red flags. Exchanges and regulators can also play their part by implementing strict KYC and AML policies, using market surveillance systems, and imposing fines to deter and detect wash trading.

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