What is wash trading?

In general, wash trading occurs when a buyer and seller conspire to deceive the market and artificially inflate the value of security without incurring any actual risk or altering the traders’ positions. In different words, the buyer and seller send the same asset back and forth, while only publicly notifying the initial sale. In the second exchange, the security and money are repaid to their original owners at the same time. 

With NFTs, the same practice occurs, only this time, the asset is “sold” to a new wallet that the original owner also holds.

How significant of an issue is NFT wash trading?

Wash trading is a significant issue that’s distorting the price of NFTs and creating a false demand.

As per reports, 110 wash traders alone yielded $8.9 million in profit last year. In all odds, that number is even much higher than anticipated. In addition, the reports only looked at transactions completed in Ethereum and Wrapped Ethereum. Last month in April, wash trading was responsible for $18 billion, or 95 percent of overall trading volume on the NFT marketplace LooksRare. 

Not all wash traders are promising, though.

Kim Grauer, head of research at Chainalysis, illustrates that many wash traders came out negative due to the amount spent on gas versus the amount yielded from their sales. Out of the 262 wash traders, the report had a glimpse at, 152 were unprofitable, and lost $416,984, collectively. 

Is NFT wash trading Illegal?

So other than probable financial loss, what impacts do these NFT wash traders are facing — if any?

The answer to this is nothing yet.

Appreciations to both the Securities Exchange Act (SEA) of 1934 and the Commodity Exchange Act (CEA) of 1936, wash trading is illegal under federal law. The Internal Revenue Service (IRS) actually has its own rules governing wash trades. Although, given that NFTs are still fairly new, it’s difficult for lawmakers and regulators to implement instances where a clear “wash trade” has occurred. This begs the need for case law that instantly speaks to wash trading with an NFT.

You’ve been a victim…now what?

Before investing, it is necessary to apprehend how the NFT is being marketed and promoted. Comparable to the due diligence taken in evaluating a rug pull, recognizing a wash trade requires you to:

#1 actually look at the blockchain and where money is being sent 

and also,

#2 ask with the community whether they are familiar with the project and their experience with their investment. 

Doing so you may just save yourself tens of thousands of dollars. 

However, in the event, you have been the victim of a wash trade, the harsh reality is that you have an intense battle to fight for in ever seeing your money again. The lack of refinement in industry available tools/mechanisms that could precisely identify and/or predict potential risks, as well as proving intent by the “known” parties to the transaction, makes it nearly impossible to get the investment back. 

As NFTs are still developing, with respect to their regulation and oversight, applying traditional wash trading rules falls under a gray area for lawmakers. But this doesn’t annihilate the unethical and unlawful character traits that still affect the intent to mislead the market and investors. 

Finally, it will require our legal terrain to continue diving into the NFT space to better understand their mechanics, tokenomics, application, and utilization to have a more suitable understanding of how to apply the CEA and SEA to modern assets.

Source: NFTHI