Wash trading is the practice of purchasing and selling assets in a manner that is intent on manipulating or misleading the market.
Take for example, an investor that has USD 1 million in ETH. The investor mints an NFT and subsequently sells it to him or herself for USD 1 million. The NFT is effectively now worth USD 1 million from its past trading history – publically available on the blockchain.
Even if the trader was to sell the NFT on to a 3rd party at a 90% discount to the market, the wash trader would still net a USD 100k profit.
It is hard to manipulate traditional public financial securities markets for a long time without being found out by Financial Investigative Units, as to deal in securities traders need to go through Know Your Customer (KYC) with brokerage platforms or banks. Suspicious buys or sells will quite quickly be found out by the bank in question (unless it is the bank’s brokers themselves that are wash trading, in which case it will be noted by the brokers in question’s counterparties (as they will be on the losing side of all trades there will be heightened scrutiny by the counterparty’s risk department)).
But because of the nature of the blockchain, unhosted wallets (unattributed to a central entity) can be created at will, as well as NFTs minted on platforms with no KYC processes. This leaves the door wide open for NFT market price manipulation.
Cryptocurrency wash trading has been prosecuted before in certain jurisdictions, such as by the CFTC in the case of a Coinbase employee, amongst other charges leveled at the prominent central crypto exchange.
A few incoming laws will make cryptocurrency wash trading illegal in other jurisdictions, such as the EU’s Markets in Cryptoassets (MiCA), with the South Korean FSC wishing to also make price manipulation and insider trading illegal.
Currently, however, in most jurisdictions, NFT wash trading is not illegal – as the asset class has not been clearly defined by most jurisdictions as a commodity or other financial security – but is of course highly unethical.
A notable example of an NFT wash trading case would be that of ‘CryptoPunk 9998’ – pictured below – that was sold on the 28th of October 2021 for 124,457 ETH (worth USD 532 million at the time of the transaction). The ETH that was used to buy the NFT was transferred to the seller then transferred back to the buyer to repay the loan – effectively making it a flash loan – that was used to buy the digital blockchain art from Larva Labs.
The seller then put the piece on the market for 250KΞ (currently valued at $1.01B). Prior to the wash trade/flash loan, CryptoPunk 9998 had been trading in the USD 400,000 to USD 300,000 range.