A new report from the blockchain data platform Chainalysis finds that a number of traders are selling non-fungible tokens (NFTs) to themselves to artificially inflate their value. The practice, known as “wash trading,” has been long banned for the exchange of securities and futures.
Through blockchain analysis, researchers identified wash trading of NFTs by honing in on sales that were made between digital wallets owned by the same person. They found 262 users who each conducted over 25 wash trades, with one zealous wash trader selling to and buying from themselves 830 times.
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Not that those efforts necessarily paid off — even with all of that self-promotion, the 830-timer’s profits from successfully selling to other buyers didn’t make up for what they spent on gas fees. (Gas fees are what blockchain users pay to cover the costs of mining, the notoriously resource-intensive computational process that ostensibly ensures the security and integrity of cryptocurrency.)
This super-wash trader’s failed attempt to gas themselves up is not uncommon: most have found wash trading to be, well, a wash, losing more than they gain in their back-and-forth crypto self-transfers. Yet a smaller group of traders are so successful in their con that their gains overshadow the losses of the many: of the group of 262, 110 wash traders profited $8.9 million in total, with the rest losing a smaller sum of about $417,000.
Chainalysis noted that their findings were an underestimate of the true volume of NFT wash trading taking place, since they only analyzed purchases made with Ether (ETH) and Wrapped Ether (WETH) (most NFTs are bought with Ethereum, but other cryptocurrencies used include Dai and Solana).
Wash trading isn’t a practice unique to the trade of NFTs — it was rife in the trade of government bonds and railroad stocks in the early 20th century before it was outlawed in the realm of securities and futures by the Commodity Exchange Act in 1936. But because both digital wallets and NFTs can be easily generated without any sort of identity authentication, the trade of NFTs provides new opportunities for deceptive and fraudulent activity — and new challenges for regulators. For now, NFTs are a relatively unregulated domain in which wash trading, as the authors of the report indicate, “exists in a murky legal area.”
Although it is difficult by its nature to pin down the details of who is involved in blockchain transactions and for what purposes, blockchain analysis is an emergent field of scientific research that collects data recorded on cryptocurrencies’ public ledgers and studies what might be going on by modeling and graphically representing that data. This data can point to possible associations between certain digital wallets, suggesting suspect (and occasionally criminally suspect) behavior. Chainalysis uses these methods to investigate criminal activity on cryptocurrency platforms.
So far, regulators have yet to prosecute wash trading in NFTs, though they’re beginning to crack down on wash trading in cryptocurrency (the Commodity Futures Trading Commission fined Coinbase $6.5 million last March for violations including wash trading, and the EU’s proposed Markets in Crypto-Assets framework would ban crypto wash trading).
That’s historically been a problem: wash trading is common especially with the debut of new cryptocurrencies that want to present a larger volume of trading than they actually have. The report’s authors suggest that rampant wash trading would sow mistrust in NFT marketplaces, so it is in platforms’ interest to self-regulate even without the specter of law enforcement action.