By Kathy Chu, TruthDAO
As NFTs go, Noleranef #1935 doesn’t even offer a song—it’s just an endless, random collection of beeps, boops, and other electronic sounds.
Its creators say the audio stream provides a way for artists to fashion unique variations of their own songs. On OpenSea, the largest NFT trading platform in the world, Noleranef seemed like a hotter investment than Tesla.
Noleranef #1935 traded on Jan. 24 at $280 —and a day later, it sold to someone for more than $683,000 before trading hundreds more times. A new examination initiated by TruthDAO shows why this happened: the trading was fake.
Simply stated, this was a well-executed case of “wash trading” – a form of market manipulation. How it works: the same investor simultaneously buys and sells the same asset, dozens or even hundreds of times, to create the appearance of market demand.
In this case, the Noleranef NFT changed hands up to 35 times between two accounts, or “wallets,” then shifted to another pair of back-and-forth trading partners, then another. Out of the 771 transactions logged for Noleranef #1935, in fact, OpenSea classified just two of them as legitimate sales transactions.
This revelation, based on an analysis conducted for TruthDAO by blockchain security firm PeckShield, shows the problem of wash trading may be more widespread than many investors realize. By some estimates, this phony, market-distorting practice accounts for 90% - or even more -- of trading on some platforms, and 20% to 30% of NFT trades overall.
Last year, 110 traders identified as profitable wash traders of NFTs earned a combined profit of $8.9 million, says research firm Chainalysis. The profits “most likely derived from sales to unsuspecting buyers who believe the NFT they’re purchasing has been growing in value, sold from one distinct collector to another.”
Investors already have to plenty to worry about: NFT counterfeits and illegal copies that violate trademark and copyright law are commonplace across the cryptosphere. Wash trading adds another level of uncertainty. Even if an NFT is legit –- and there are plenty of examples of that, as well -– the reality is that the prices being paid may be inflated by bogus trading.
As for the vast sums being paid for some NFTs, it’s anybody’s guess as to whether those assets were also hyper-inflated. NBA star Stephen Curry paid $180,000 for a Bored Ape Yacht Club NFT. Rapper Eminem paid around $450,000 for his, and genre-bender Justin Bieber paid $1.29 million for one with a teary ape in a black t-shirt.
To hear experts tell it, there simply is no way to be 100% certain that those prices were fair and free of wash-trading manipulation. If a wash trader wanted to avoid detection, the person could open up many wallets and use each only once, making it very difficult to identify the manipulation, according to Friedhelm Victor, a doctoral student at the Technical University of Berlin who has studied wash trading in the crypto world.
Despite the risks, the NFT business is booming. Sales of NFTs, which are unique digital assets of art, video, music and even tweets, are expected to reach $30 billion this year -- after growing 570-fold between 2020 and 2021, according to data research firms Forkast and CryptoSlam. Data firm Chainalysis estimates NFT sales could top $40 billion this year.
Similarly, a study of bitcoin trading three years ago found that a stunning 95% of all reported trades were fake. Bitwise Asset Management hasn’t updated its report, which roiled the crypto industry when it came out.
Mounting evidence shows the market manipulation once rife in bitcoin is migrating to NFTs and less-developed crypto markets, distorting trades, creating fake demand, and inflating prices for unsuspecting investors. Victor, the doctoral student at the Technical University of Berlin, found last year that more than 30% of tokens traded on two decentralized crypto exchanges were wash traded. The bogus trades generated, conservatively, $159 million in transactions, he estimates.
“It’s the same circus, different clowns,” says Zennon Kapron, managing director of Kapronasia, an Asia-based blockchain consulting firm. According to Kapron, what’s happening now in the crypto world parallels the high-frequency wash trading that took place in the U.S. securities markets a decade ago.
Some 17% of the 4.4 million digital wallets tracked by research firm bitsCrunch, based in Munich, Germany, are involved in wash trading. Overall, the firm says wash trading accounts for 11% of the 32.1 million NFT transactions it currently tracks.
Meanwhile, an examination last year of seven NFT exchanges revealed wash trading in 29% of NFT collections with more than $2,000 in trading volume. The research, led by Dipanjan Das and Priyanka Bose, doctoral candidates at the University of California at Santa Barbara, also found that traders were placing fake bids to pump up the prices of NFTs.
The research likely understates the degree of market manipulation because of the growing sophistication of these schemes, the study’s authors say.
Market manipulation is more pronounced on some platforms. On LooksRare, wash trading accounted for a staggering 95% of all trading volume in the first quarter –- equaling $18 billion in bogus trades, says blockchain data firm CryptoSlam.
On another platform, Rarible, wash trading made up most sales exceeding $1,000 at one point in 2020 – so says data firm NonFungible. In one tweet, the firm soberly noted that wash trading “renders all statistics misleading and dangerous to users.”
LooksRare didn’t respond to requests for comment. Rarible co-founder Alex Salnikov said in a statement that the platform, which used to give out tokens based on trading volume, stopped that practice this year. Rarible says it is now working to “permanently end” wash trading.
Further complicating the wash trade picture is this reality: A small number of NFT traders can -- and often do -- have an outsized influence on the marketplace. The top 10% of traders accounted for 85% of the six million-plus NFT trades between June 2017 and April 2021, according to research published in Scientific Reports. In addition, the top traders handled 97% of all NFTs at least once, according to research led by former doctoral student Matthieu Nadini, now a data scientist in the crypto industry. The research did not examine how many of those traders actually engage in wash trading.
Crypto leaders worry that wash trading could discourage investors from buying NFTs and other crypto currencies, hindering the industry’s growth. “It certainly doesn't help the perception and the legitimacy of the industry,” says Sheila Warren, CEO of the Crypto Council for Innovation, a lobbying group that represents a global alliance of major crypto players.
To date, many institutional investors have stopped short of embracing NFTs – another byproduct of the harms inflicted by scammers and fraudsters. But as NFTs continue to gain traction with the mainstream, institutions will demand transparency, which in turn could help curtail wash trading. That’s what happened in the bitcoin industry, recalls Wilfred Daye, head of Securitize Capital, an asset-management firm that offers bitcoin and ETH yield funds.
Until then, industry experts say NFT investors had best be careful out there, because some forms of wash trading are difficult to detect -- and almost impossible to stop.
"This problem is only going to get worse before it gets better,” said Nitin Kumar, co-founder of zByte, a platform that allows companies to build digital apps on the blockchain. “The more immature the market is, the more subject it is to manipulation.”
Related story: Do Fake Trades Call NFT Market Size into Question?