when market manipulation affects NFTs

Wash trading: when market manipulation affects NFTs

Marketplaces with distorted transaction volumes, collections with inflated prices, the NFT market still has to deal with dubious practices.

In the traditional finance sector, market manipulation consists of carrying out operations whose consequences will distort the information intended for the players in the ecosystem. In a regulated sector, this type of practice is reprimanded.

Still emerging and above all largely decentralized, the NFT market is not under the supervision of an authority, at least for the moment. A lack of regulation means an increased risk of manipulation.

This occurs in different ways, either by the marketplaces themselves, or by the creators or even by the users.

NFT marketplaces, victims or responsible?

Dominated for several years by the OpenSea platform, born in 2017, the NFT marketplace activity has been driven by the appearance of many players, particularly over the past two years with the arrivals of Rarible (2020), Magic Eden (2021 ), Looks Rare and X2Y2 (2022).

In this competitive sector, some therefore go through suspicious processes to stand out, in particular the use of wash trading, that is to say the artificial creation of transactions in order to inflate the volume of exchange and therefore the activity.

Capture of the X2Y2.io website. © JDN

“We first had the case with Rarible, it was the first example”, confides Gauthier Zuppinger, co-founder of the analytical site NonFungible.com and author of a conference entitled “The truth about market manipulation ” at the NFT. London. “Subsequently, we saw LooksRare, X2Y2 lend themselves to this. The latter is one of the biggest examples with over $500 million per month in wash trading. In 2022, we saw that 12% of trades on the market corresponds to wash trading. It is significant enough to blur the reading of a market.”

It is important to specify that the wash trading of NFT marketplaces is an open secret, the presentations of another data agglomeration site Dune.xyz moreover corroborates the words of the boss of NonFungible and even present marketplace assessments excluding suspicious transactions.

Among the main interested parties, the development manager of X2Y2 does not deny the presence of washtrading but disputes the responsibility of the platform. “It’s not something we support,” replies Derek Caussin. Ourselves, when we draw up our monthly statistics internally, we publish the figures without wash trading. Simply, our protocol was designed to reward the most active and traders abuse it.”

This is indeed another explanatory factor for wash trading: some platforms like Rarible, LooksRare and X2Y2 have created their own token, most often used as a reward to incentivize transactions on the platforms. In fact, some users generate tokens by carrying out transactions around the same assets.

“Pay to trade encourages wash trading”

“This is the most common case,” said Gauthier Zuppinger. “It pays very, very well. This reward mechanic, pay to trade, encourages wash trading.”

According to the analyst, one of the most obvious patterns is that of repeated transactions between two wallets, usually owned by a single holder. Nevertheless, the current models would be more and more complex with dozens of portfolios and assets involved, making the task of observers particularly difficult, if not impossible for a neophyte.

“You have to look at the sales history. If you observe too much recurring activity, an always similar transaction value or wallet addresses that come up too often, there is probably something strange. Nevertheless, this t is more and more complex for an untrained user to arrive on a marketplace and try, on their own, to understand what is going on. It takes a lot of time and you have to handle a huge amount of data”, slips Gauthier Zuppinger, whose team does not rely on the APIs of the marketplaces, potentially distorted, but on the direct analysis of the activity of the blockchains.

Creators of NFT works sometimes responsible

NFTs now number in the millions, on a growing number of networks such as Ethereum, Polygon, Flow, Tezos, Immutable X, Wax, etc. A jungle in which creators must also stand out. In fact, some adopt a strategy similar to that of marketplaces, by artificially inflating the price of their collection. All you have to do is create larger and larger transactions around the same asset, or an entire collection. “In summary, a user will trade himself an NFT at the price of several ethers (one ether is worth around 1160 euros as of November 16, 2022, editor’s note) in order to inflate its price and give it visibility”.

And thus take advantage of the liquidity of an inexperienced collector.

In 2020, NonFungible.com was already talking about obvious cases, from Cryptokitties to certain assets of the Decentraland metaverse.

Even if zero risk does not exist, there are signs to best protect against falling into the trap of NFTs with artificially stimulated value:

  • In this maturing sector, the creators of NFTs are less and less anonymous. Without it being a rule, an unidentified creator constitutes an additional risk.
  • As far as possible, it should be verified that the smart contract at the origin of the NFT has been audited. Although it is not foolproof, verification badges exist on some marketplaces and explorers like Etherscan (for the Ethereum network) have also implemented it for certain types of assets.
  • In the case of collectibles, it is important to check how widely the collection is distributed. The OpenSea platform now indicates the number of unique holders within the same collection. Too much concentration in the hands of a single collector is generally a bad sign.

Finally, common sense must prevail. Even if the method is once again not perfect, online verification of the history of an artist or a team is important and it should always be kept in mind that NFTs likely to reach a high valuation are not the most frequent: according to the firm Nansen, of the 29,000 collections deployed on Ethereum between 1er January and June 30, 2022, two-thirds raised less than 5 ether.

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