What is wash trading and money laundering in NFTs?

What is crypto wash trading?

Shadow trading occurs when a trader or investor buys and sells the same securities multiple times over a short period of time to mislead other market participants about an asset’s price or liquidity.

As mentioned, the wash trade involves an act in which the same asset is sold and bought within a short period of time. To influence trading activity and the price of an asset, traders use wash trading as a market manipulation technique. Typically, one or more colluding agents undertake a series of transactions without regard to market risks, resulting in no change in the initial position of the antagonistic agents.

In October 2021, Cryptopunks, an NFT project by Larva Labs, witnessed something like a “spawn sale” on the Ethereum blockchain. Cryptocurrency “CryptoPunk 9998” was sold for 124,457 Ether (ETH). The ETH used to buy the NFT was transferred to the seller and then returned to the buyer to repay the loan used to buy the digital blockchain art from Larva Labs, making it not just a flash loan, but a prominent example of NFT money laundering.

A trader or business may be motivated to engage in fictitious trading for a variety of reasons. For example, the objective could be to stimulate buying to increase prices or to encourage selling to drive prices down. A trader may make a wash sale to lock in a capital loss before repurchasing the asset at a reduced cost, essentially seeking a tax refund.

How does a laundry business work?

The intention of the parties involved in the fictitious trade and the outcome of such a transaction enables the fictitious trade to fulfill its purpose.

A wash trade occurs when an investor simultaneously buys and sells tokens of the same asset. The definition of fictitious transactions, on the other hand, goes further and considers the objective or intention of the investor and the outcome of the transaction.

The intention of traders or investors must be related to the fictitious trade, and they must have bought and sold assets with a common beneficial owner within a short period of time. Beneficial ownership refers to accounts owned by the same person or company.

Financial regulators may be interested in transactions made between accounts with a common beneficial owner, as they could indicate fictitious trading activity. However, washing operations do not always have to involve real transactions; they can also occur when investors and brokers appear to be doing the transaction on paper, but no assets are being traded.

Why is wash trading illegal?

Wash trading is prohibited in traditional finance. The legality of wash trading, on the other hand, has yet to be determined in the decentralized realm of non-fungible tokens (NFTs).

Despite the lack of legislation and classification for NFT, some governments have opposed the practice. For example, Bithumb, a South Korean crypto exchange, was accused in 2018 of facilitating wash trade worth over $250 million in bogus volume.

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

Even though crypto wash trading is banned in some jurisdictions, the decentralized structure of cryptocurrencies makes it difficult to find the culprits. Unlike traditional financial instruments such as stocks, which have verified Know Your Customer standards, blockchain-powered assets can be traded anonymously, resulting in the risk of shadow trading. The risk stems from misleading price and volume statistics, which can only be eliminated if authorities decide which jurisdiction is responsible for overseeing crypto.

How are NFTs used to launder money?

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

Money laundering has long been a problem in the art world, and it’s easy to see why. Many people ask if NFTs are subject to similar abuse due to their history and the pseudonymization of crypto assets. So, can you launder money through NFTs?

Yes, scammers, malware operators and Chatex are laundering money using NFT. Chatex is a cryptocurrency bank that aims to make cryptocurrency transactions secure, simple and accessible to many customers while maintaining a functional advantage over traditional banking.

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

Wash Trading scams have been tracked by Chainalysis by looking at NFT sales to “self-funded” addresses, i.e. sales funded either by the address that originally funded the selling address, or by the selling address itself.

Hundreds of wash trades have been discovered using this strategy. For example, one user, whom Chainalysis identified as the most active wash distributor, was found to have made 830 sales to addresses he had self-funded.

Why is wash trading a problem for the NFT space?

The NFT wash trade is a problem for investors, the global community, collectors, and traders, as these participants use less liquid, non-fungible tokens to manipulate the price of an asset.

Due diligence has become more difficult as investors have been forced to rely on measurable statistics, making poor investment decisions. To encourage NFT investments and prevent NFT scams, discrepancies in data should be investigated by specialists. Additionally, NFT crimes hit the NFT community the hardest. Regulators and proponents of traditional financial services can now use shadow commerce to fight decentralization.

Collectors and dealers alike are unable to make informed judgments. When misleading facts and history deceive people regarding a work of art or collectible, it’s easy for them to make rash decisions. So, with NFT markets impacted by wash trading, is there a way to spot it in the first place?

There is no price or volume history associated with new coins when they are introduced to the market. As a result, developers or other insiders may participate in fictitious transactions to mislead participants about the true value of the coin. Therefore, avoid investing in such projects.

Additionally, many NFTs have no trading volume or interest for investors. As a result, NFT owners can easily participate in the fictitious trade to entice naïve buyers into buying the NFT at an exorbitant price. Therefore, avoiding small cap cryptos and newly issued NFTs is the most effective way to prevent the washout trade.

A trader should choose more established cryptocurrencies with higher volume to avoid falling victim to the wash trade. The larger the market, the more money fraudsters will need to manipulate it. For example, already established cryptos like Bitcoin (BTC) or Ethereum, which are worth hundreds of billions of dollars, make crimes like wash trading incredibly difficult.

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