What is wash trading and why is it harmful to NFT trading?

    Wash trade is a type of market manipulation in which an investor or a seller sells and buys the same financial assets at the same time to produce fake, misleading activity in the market and garner a buyer’s interest.

    An investor will first place an order for their asset, then a buy order to purchase from themselves, or vice versa. This will create a misleading ‘demand’ as a buyer will be attracted to the highly active good.

    No, wash trading is not legal. The commodity exchange act prohibits it, and there is a penalty for manipulating the market illegally. But what if we are talking about a decentralized platform?

    Non-fungible tokens are decentralized units of data stored on the blockchain. The transactions at NFT marketplace take place using cryptocurrency (in most of the cases) but, crypto is banned in many countries like China. This questions the legal status of NFTs in many countries. It also gives sellers an opportunity to manipulate NFT marketplace.

    How it’s done.

    Several NFT trading platforms allow users to trade without identifying themselves by just connecting their wallets to the site. This means that a single user can establish many wallets and link them to a platform.

    After that, a person can control both sides of transaction, selling it from one wallet and buying it from another. The trade volume increases as numerous similar transactions are completed. As a result, the underlying asset appears to be in high demand. Some wash traders have gone so far as to use their self-controlled wallets to make hundreds of transactions.

    According to Chainalysis, over 250 users traded over 25 times each with self-financed wallets. Surprisingly, the majority of wash traders lost money on these trades. In fact, roughly 15 percent of sellers and investors who engaged in outwash trades lost around $400,000. The remaining users, on the other hand, made a stunning $8 million profit.

    Experts believe that wash trading will gain momentum in coming years.

    What the NFT Marketplaces are doing to protect their users.

    While no one can have control over a user in a decentralized market, some of the NFT platforms have taken steps to lessen the risk of wash trading by developing tech-based solutions.

    To detect such fraudulent conduct, powerful techniques are being created. These tools can now tell if the buy and sale wallets are both financed by the same address. Hundreds of such wash deals in the NFT space have been discovered after a thorough examination of NFT sales.

    Platforms that compensate users for executing transactions, according to Alex Salnikov, Co-founder and Product Head at NFT marketplace Rarible, were the most misused because they added profitability to the money-making racket.

    Acting on Salnikov’s suggestion, Rarible’s DAO (decentralised autonomous organisation) voted to stop paying RARI tokens to traders. It is no longer vulnerable to wash trading.

    In January 2022, OpenSea published a blog post announcing the formation of a new ‘NFT Security Group.’ The team will concentrate on resolving vulnerabilities before the consequences reach users. They’ll do so by pooling their ideas and acting on reports that haven’t been made public. The crew will use what they’ve learned to develop strategies to keep wash traders at bay and improve the NFT platform’s overall security.

    Users are also advised to thoroughly check the source of their NFT trades before purchasing or investing in them.

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