1.

What is Wash Trading Cryptocurrency?

Wash trading occurs when a trader or investor buys and sells the same security multiple times within a short period of time to deceive other market participants about the asset's price or liquidity.

As mentioned earlier, wash trading involves the act of buying and selling the same asset within a short period of time. In order to influence the trading activity and price of an asset, traders use wash trading as a market manipulation technique. Typically, one or more colluding agents conduct a series of trades without considering market risk, resulting in no change to the original position of the hostile agent.

In October 2021, Larva Labs NFT project Cryptopunks witnessed a “wash sale” on the Ethereum blockchain. Cryptocurrency "CryptoPunk 9998" sold for 124,457 Ether (ETH). The ETH used to purchase the NFT was transferred to the seller and then returned to the buyer to repay the loan used to purchase the digital blockchain art from Larva Labs—effectively not only a flash loan, but an example of significant NFT money laundering.

A trader or firm may be incentivized to engage in wash trading for a variety of reasons. For example, the purpose may be to stimulate buying to increase prices or to encourage sales to lower prices. Traders may engage in wash sales to lock in capital losses and then buy back the assets at a reduced cost, essentially seeking a tax refund.

2.

How does wash trading work?

The intentions of the parties involved in a wash trade and the results of such transactions allow a wash trade to achieve its purpose.

Wash trading occurs when investors buy and sell tokens of the same asset at the same time. The definition of wash trading, on the other hand, goes a step further and takes into account the goals or intentions of the investors and the outcomes of the trades.

The intention of the trader or investor should be related to wash trading and they should buy and sell assets with common beneficial ownership within a short period of time. Beneficial ownership refers to accounts held by the same person or company.

Financial regulators may be interested in transactions between accounts with common beneficial ownership as they may indicate false trading activity. Still, wash trades don’t always involve real trades; they can also occur when investors and traders appear to be trading on paper, but no assets are being exchanged.

3.

Why is wash trading illegal?

Traditional finance prohibits wash trading. On the other hand, in the decentralized world of non-fungible tokens (NFTs), the legality of wash trades has yet to be established.

Despite the lack of legislation and classification for NFTs, certain governments have opposed the practice. For example, South Korean cryptocurrency exchange Bithumb was accused in 2018 of facilitating wash trading of over $250 million worth of fake volume.

On April 5, 2022, Bloomberg reported that data from NFT tracker CryptoSlam showed that wash trades accounted for $18 billion or 95% of the total trading volume of the NFT market called LooksRare.

Although some jurisdictions prohibit cryptocurrency wash trading, the decentralized structure of cryptocurrencies makes it difficult to track down the culprits. Unlike traditional financial instruments such as stocks, which have verified Know Your Customer standards, blockchain-driven assets can be traded anonymously, leading to the risk of wash trading. The risk arises due to misleading price and volume statistics, and it cannot be eliminated unless authorities decide which jurisdiction is responsible for regulating cryptocurrencies.

4.

How are NFTs used for money laundering?

NFT crimes such as money laundering and wash trading scams occur when NFT sales are targeted to “self-funded” addresses.

Money laundering has long been an issue in the art world, and it’s easy to understand why. Many have asked if NFTs are subject to similar abuse due to their history and pseudonymity as crypto assets. So, can you launder money through NFTs?

Yes, scammers, malware operators, and Chatex use NFTs for money laundering. Chatex is a crypto bank that aims to make cryptocurrency trading safe, simple, and accessible to many customers while maintaining functional advantages over traditional banking.

While money laundering in physical art is difficult to quantify, the inherent openness of blockchain allows us to make more realistic estimates of NFT money laundering. Therefore, money laundering occurs in the NFT market.

Chainalysis tracks wash trade scams by looking at NFT sales to addresses that are “self-funded,” meaning sales are funded from the address that originally funded the sale address or from the sale address itself.​

Hundreds of wash trades were discovered using this strategy. For example, one user identified by Chainalysis as the most active wash dealer was found to have made 830 sales to their self-funded addresses.

Related: What is front-running in cryptocurrency and NFT trading?

5.

Why is wash trading a problem in the NFT space?

NFT wash trading is a problem for investors, the global community, collectors, and traders because these actors use less liquid non-fungible tokens to manipulate asset prices.

Due diligence becomes more difficult as investors are forced to rely on measurable statistics and make poor investment decisions. To encourage NFT investment and prevent NFT scams, discrepancies in the data must be investigated by experts. Additionally, NFT crime hits the NFT community hardest. Regulators and supporters of mainstream financial services can now use wash trading to fight devolution.

Likewise, collectors and merchants are unable to make informed judgments. When deceptive facts and history mislead people about a piece of art or collection, they can easily make rash decisions. So, as the NFT market is affected by wash trading, is there a way to spot it as soon as possible?

When new tokens are released to the market, there is no price or volume history associated with them. Therefore, developers or other insiders may engage in wash trades to deceive participants into knowing the true value of a coin. Therefore, avoid investing in such projects.

Additionally, many NFTs have no trading volume or investor interest. As a result, NFT owners can easily engage in wash trading to lure naive buyers into purchasing NFTs at inflated prices. Therefore, avoiding newly issued small-cap coins and NFTs is the most important way to prevent wash trading.

Traders must choose cryptocurrencies that are more mature and have higher trading volumes to avoid falling victim to wash trading. The wider the market, the more scammers have to manipulate it. For example, established cryptocurrencies such as Bitcoin ( BTC ) or Ethereum, worth hundreds of billions of dollars, make crimes such as fake transactions extremely challenging. #nftcommunity