NFT Wash Trading Skyrockets: Are Fake Volumes Distorting the Market?

Is the vibrant NFT market being shadowed by a less desirable practice? Recent findings from CoinGecko reveal a concerning trend: NFT wash trading is on the rise. As NFT trading volumes fluctuate, so too does the specter of artificial inflation, raising questions about the true health and value within the digital collectibles space. Let’s dive into what this means for you and the future of NFTs.

What’s Fueling the NFT Wash Trading Surge?

CoinGecko’s latest investigation shines a spotlight on the murky waters of NFT wash trading. Their report highlights a significant jump in fake trading activity, coinciding with the overall NFT market’s movements over the past few months. February alone witnessed a staggering $580 million in wash trades across the top six NFT marketplaces. This represents a dramatic 126% increase compared to January. That’s a massive leap!

But what’s behind this surge? CoinGecko points a finger at marketplace incentives. Think about it: platforms sometimes offer rewards or prizes based on trading volume. This creates a tempting scenario for users to game the system, artificially inflating their transaction numbers to snag those perks. Essentially, it’s like earning points for transactions, even if those transactions are just you trading with yourself.

The Scale of the Problem: Numbers Don’t Lie

The numbers paint a stark picture. According to CoinGecko’s data, wash trading accounted for a hefty 23% of the unadjusted trading volume across the top six marketplaces in February. Out of a total of $1.89 billion traded, almost a quarter was potentially fabricated. That’s a significant chunk of the market that might not be genuine user activity.

Which platforms are seeing the most wash trading?

• X2Y2 tops the list, contributing a whopping $280 million to the wash trading volume, representing 49.7% of the total.
• Blur follows with $150 million, accounting for 27.7%.
• LooksRare is also a significant player, with $80 million in wash trades, or 15.1%.

These three platforms alone constitute the vast majority of the reported wash trading activity. It’s important to note that this doesn’t necessarily mean these platforms are *intentionally* facilitating wash trading, but rather that their mechanisms and incentives are being exploited.

Wash Trading Explained: Trading with Yourself?

For those new to the concept, let’s break down what wash trading actually is. Imagine you’re trying to sell an NFT, but there’s not much interest. To create the illusion of demand and potentially drive up the price, you engage in wash trading. This involves:

• Controlling both the buyer and seller sides of a transaction. Essentially, you’re selling to yourself, or to an account you control.
• Repeatedly buying and selling the same asset. This creates fake volume and artificially inflates the perceived value or liquidity of the NFT.

The goal isn’t genuine trading or investment; it’s manipulation. Wash trading can be used to:

• Artificially inflate prices. Making an NFT look more valuable than it is.
• Create the illusion of liquidity. Making it seem like there’s high demand and activity for a particular NFT or collection.
• Profit from platform incentives. Exploiting reward systems designed for genuine traders.

Is Wash Trading a New Phenomenon?

While the recent surge is noteworthy, wash trading in the crypto world isn’t exactly new. A National Bureau of Economic Research report from December highlighted that a staggering 70% of transactions on noncompliant crypto exchanges like Binance were estimated to be wash trades. That’s a huge number and indicates a long-standing problem within the broader crypto ecosystem.

Investor Mark Cuban has even voiced concerns, warning TheStreet that wash trading on centralized exchanges could trigger crypto’s next “potential implosion.” His warning underscores the serious risks associated with market manipulation and the potential for it to destabilize the entire crypto space.

Looking specifically at NFTs, Dune Analytics data from December also revealed that over 80% of NFT trading activity in January 2022 was suspected to be wash trading. While CoinGecko’s recent 23% figure suggests a decrease from those peak levels, it’s clear that wash trading remains a persistent issue in the NFT market.

Token Incentives: A Double-Edged Sword?

CoinGecko points to token incentives as a significant contributing factor to the recent uptick in wash trading. The launch of Blur’s native token, $BLUR, and its associated airdrop programs, which reward users for trading activity, seem to have directly fueled the increase. CoinGecko noted that wash trading tripled in February after Blur introduced these token-based rewards.

Blur, in particular, has become a hub for wash trading due to a combination of factors:

• Low transaction fees. Making it cheaper to conduct frequent trades, even if they are wash trades.
• Token rewards for trading activity. Directly incentivizing users to trade more, regardless of the nature of those trades.

Theoretically, users could profit by simply moving NFTs between their own wallets on Blur, as long as the token rewards and incentives outweighed the gas fees associated with those transactions. This creates a perverse incentive structure that encourages artificial trading volume.

Blur’s Market Dominance and the Wash Trading Effect

Blur’s strategy appears to be working in terms of market share. In the first week of March, Blur reportedly secured a massive 84% of Ethereum-based NFT transactions. This rapid growth in market share, achieved in just two months, coincides with the surge in wash trading. It raises the question: is Blur’s dominance partly built on a foundation of inflated trading volumes?

Other platforms like X2Y2 and LooksRare also utilize token payout systems based on users’ previous day’s trading volume. CoinGecko estimates that these marketplaces have 85% and 81% wash trade rates, respectively. Chainalysis reported in February that 110 addresses had already made $8.9 million by exploiting these types of incentive programs. This highlights the financial motivation behind wash trading and the potential for significant illicit gains.

The Future of NFT Trading: Will Wash Trading Persist?

As Blur continues to dominate the NFT marketplace landscape, the concern is that wash trading could become even more prevalent. Blur’s bidding-incentive approach, which has led to users bidding *above* asking prices for NFTs in certain collections, further complicates the picture. As The Block previously reported, this can create opportunities for “reverse arbitrage,” where individuals profit from transaction fees and listing/bidding incentives, further fueling wash trading activities.

Key Takeaways and What It Means For You

So, what should you take away from all of this?

• NFT wash trading is a significant issue. It distorts market data and can create a false sense of value.
• Marketplace incentives can inadvertently encourage wash trading. Token rewards and low fees, while attractive to users, can be exploited.
• Be cautious when interpreting trading volume data. High volume doesn’t always equal genuine demand.
• Do your own research. Don’t rely solely on reported trading volumes when evaluating NFTs or marketplaces. Look deeper into project fundamentals and community sentiment.
• The NFT market is still evolving. As the market matures, expect to see more discussions and potential solutions to address wash trading and ensure a fairer and more transparent ecosystem.

Wash trading casts a shadow over the exciting world of NFTs. While it’s a challenge, understanding its dynamics is crucial for navigating this space wisely and making informed decisions. As the NFT market continues to evolve, addressing issues like wash trading will be vital for building long-term trust and sustainability.