Market manipulation – to influence the price of a product for personal gain – is as old as the road to Rome. This also occurs in the world of NFTs (non-fungible tokens) and crypto. This is called wash trading. How exactly does that work?
“Market manipulation has been going on for hundreds of years,” said Bitcoin Alpha analyst Bert Slagter. “This occurs when you, as a buyer or seller of something, do not want to give a clear picture of the market. A product is bought or sold without the purpose of keeping or using it. The goal is to manipulate the price.”
“Compare it with the market in the city,” says Maarten de Borst of consultancy firm Numbers. “For example, a painting is being sold there and people are bidding against each other. Others walk by and think that it must be a very special painting and start bidding. In the end you pay way too much for that painting and it turns out that the other bidders colluded with the market vendor. They share the profit together.”
What is wash trading?
With NFTs or crypto you do not own a tangible painting or physical coin, but a digital product. That can be a picture of a monkey, or a digital coin. Market manipulation also occurs here. A form of market manipulation is wash trading. That means that the buyer and seller of a digital product work together to manipulate the market for their own gain. It is made very easy if you can create multiple ‘addresses’ yourself, so that you can buy and sell something to yourself. Without it being immediately clear that it concerns one and the same person.
“They can have all kinds of goals with this,” says Slagter. ,,For example, to push up the price of a product. Because what is the price of an NFT? That is the level of the very last sale. You can meet up with friends to buy something and then sell it again. The price is going up, which may lead others to think they have to jump into this new market.”
Another goal of wash trading can be to create volume. Trading volume is the number of times a product or financial instrument has been sold. De Borst: “Suppose you spend 10,000 NFTs with a starting value of 1 euro each. The trading volume is zero at the start of the day. Then you agree that friends will buy up all those (worthless) NFTs in one day. For example, the trading volume at the end of the day is 10,000. The market then thinks: something is happening here, I have to be there. And not only people are catching on to this, trading algorithms are too. You and your friends then sell those worthless NFTs to others and count your profits. What made this form of market manipulation even more lucrative was that marketplaces rewarded merchants for trading. And as long as that reward (in cryptocurrencies) is higher than the transaction costs, you have risk-free profit.”
So why is volume so important? “It says something about the market,” says Slagter. “If there is little volume, there is little to trade. Therefore it is a very important element. It also says something about the trading platform. They also compete with each other in trading volume. So if you want to get higher in lists of the best platforms as a trading platform, wash trading can help with that. Such a trading platform should have the role of gatekeeper, but it therefore also has interests in this.”
So tens of billions were pure wash trading
That is why wash trading is also prohibited. “It is outright fraud,” says De Borst. “An analyst on data platform Dune has shown that about 58 percent of the trading volume in NFTs in 2022 was fake. So tens of billions were pure wash trading.” A figure that does not surprise Slagter either. “I believe this is just the tip of the iceberg.”
Slagter: “In recent years, the trade in NFTs has been a hype. It was a bubble. Total madness. Extremities and fraud always arise in this. That is simply inherent to the Wild West with an emerging new technology. We also saw this, for example, with the reliability problems in the early days of the internet. The air will go out when the hype is gone. We notice that now. There is less interest in NFTs, volume is falling and prices are falling. We are now in the construction period for legislation after the hype.”
How can wash trading be prevented?
Trading platforms therefore sometimes have conflicting interests. Strict rules are difficult to make, because government legislation differs per country. If the Netherlands makes a rule, the platform can move to another country where this rule does not apply. De Borst: ,,As a trading platform, think of it as a casino that is attractive if there is a lot to play. Yes, there are sometimes cheaters, but anything better than an empty casino. The trading platforms themselves now also recognize that wash trading and complete anonymity are undesirable. That is why more and more platforms ask to go through an identity check. This is to prevent you from creating multiple accounts.”
That is why the European Union is now working on MiCA legislation, which will include fixed rules and enforcement. “This one is almost finished,” says Slagter. “Then platforms may only be active on the European market if they are under supervision. By being active I mean: if they clearly focus on the Dutch market, for example by offering their website in Dutch, advertising or by creating an iDeal link. If you don’t do all this, you can still be there. But then it’s up to the people themselves not to go there. There will have to be information campaigns for this, that you should only go to a trading platform if it is under MiCA supervision.”
Until then, it will remain difficult for consumers to recognize wash trading. Butcher; “Consumers should really stay away from these speculative assets. I’m talking about those NFTs or small coins that are being hyped. Because then you, as a consumer, are actually better off going to the casino.”
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