Researchers Argue that Wash Trading Might become Problem in Fast-Growing Blockchain based NFT Market

A digital artwork piece by Beeple recently set auction records (on Thursday / March 11, 2021)  when it sold at Christie’s for $69 million.

Twitter CEO Jack Dorsey is auctioning the NFT or non-fungible token for the first tweet ever, “just setting up my twttr,” with the highest bid reaching $2.5 million. Meanwhile, NBA Superstar LeBron James’ in-game highlights are selling for six figures.

The digital assets space is now booming, with many eager buyers paying really large amounts for NFTs that give them “exclusive” ownership of virtual collectibles. Many people have been offering explanations for why these unique digital tokens have been selling for fortunes.

Some argue that NFTs may have become increasingly popular because Bitcoin and the wider crypto market have reached unprecedented levels. BTC, the world’s leading digital currency, recently surpassed the $60,000 mark and has a market cap of well over $1 trillion at the time of writing.

It’s possible that many of the people who’ve made sizable profits from their cryptocurrency holdings may now be using the funds to purchase digitally scarce NFTs.

However, there’s now a seemingly nefarious suggestion that’s appearing on various message boards, Twitter and different blogs which alleges that these surging prices may be at least partially due to wash trading (which takes place when traders purchase and sell the same assets in order to create the illusion of very high volumes on exchanges).

As noted by Bloomberg, wash trading is often referred to as “crypto’s open secret” and serious concerns about these abusive practices have been associated with crypto-asset trading for many years.

The US Securities and Exchange Commission (SEC) noted in 2019, as part of a response to a Bitcoin ETF application, that “fraudulent and manipulative activity” in the cryptocurrency market was one of the main reasons the request for offering the exchange-traded-fund was denied.

In an all-digital environment where identities can easily become abstractions with complex alphanumeric symbols used for virtual wallet addresses, claiming wash trading can seem likely but can become difficult to actually prove.

Being able to accurately identify self dealing or wash trading may need forensic accounting methods such as applying Benford’s law or carefully looking at trade size distributions and seeing how they compare with mathematical principles such as Pareto-Levy.

Matthieu Soule, Head of BNP Paribas C.Lab Americas, noted that digital currency exchanges today are “not regulated as much as regular exchanges where wash trading is clearly prohibited by regulators.” Soule also mentioned that this “means that today’s investors have to trust the platforms where they are transacting on to prohibit and monitor such wash trade practices.”

Nifty Gateway, a major NFT exchange, claims that it closely monitors questionable or potentially fraudulent transactions on its system.

In statements shared with Bloomberg, a Nifty Gateway representative claimed:

“To date we haven’t seen any evidence of wash trading on our platform, and we do monitor sales for abnormal activity. The majority of our customers purchase Nifties with credit cards, which require them to provide some personally identifiable information, and limits the risk of wash trading.”

However, there are some indications that there could be at least some wash trading going on in these nascent markets. Analysts from managed to flag a Blockchain Cuties character that was being traded repeatedly between only two accounts during the course of just a single day.

Research performed by academics also reveals that NFT markets might involve illicit activities.

Will Cong, a Cornell University professor who wrote a research paper on irregular trading activity on virtual currency exchanges, stated that he has not seen a noticeable or significant difference between the incentives to engage in wash trading in NFT markets and regular currency markets.

Cong added that “fraud detection is hard” and “even if they are all non-fungible, they’re still anonymous and it would be hard to track down market manipulators.”

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