Forta is a real-time detection network for security monitoring of blockchain activity. The decentralized Forta Network scans all transactions and block-by-block state changes, leveraging machine learning to detect threats and anomalies on wallets, DeFi, NFTs, bridges, governance and other Web3 systems. When issues are detected, Web3 infrastructure can respond to prevent attacks via transaction screening and incident response.
Quantifying suspicious behavior in NFT markets
Non Fungible tokens have recently developed into a new financial market segment notorious for wash trading activity. Wash trades are made when users swap tokens between two or more of their own wallet addresses, most often to boost asset prices and volumes artificially, or to harvest marketplace rewards. The presence of wash trades can entirely distort the apparent fair value of tokens in a collection. They should therefore be detected and excluded from further financial assessments such as token valuations and appraisals. This letter introduces three novel strategies to flag transactions for suspicious wash activity, tailored to the NFT markets.
Wash trading is when the buyer and seller in a transaction are the same person or two people colluding. It’s banned in conventional financial markets because it misleads the rest of the market about the true level of demand, distorts prices and entices others to trade on fake information.
This activity has been illegal in many traditional markets in the U.S. since the passage of the Commodity Exchange Act (CEA) of 1936.Historically, wash trading has been an issue for cryptocurrency exchanges attempting to inflate their trade volumes – for example, Bitwise Asset Management claimed in 2019 that up to 95% of all reported bitcoin (BTC) trading volume on exchanges is faked.
What is NFT wash trading ?
Non Fungible tokens (NFTs) are blockchain-based assets that are one-of-a-kind and cannot be interchanged. NFTs prove ownership on a digital ledger system and are bought and sold online in specialized marketplaces. Like the high-end art world, NFTs are subjective, and value is based on demand.NFT popularity skyrocketed with Chainalysis’ NFT Market Report, stating $44.2 billion of cryptocurrency was sent between two Ethereum smart contracts in the NFT marketplace in 2021, which increased by more than $106 million from 2020. In February 2022, Chainalysis published a blog post showing its findings from an NFT wash-trading analysis. It discovered 262 users who had sold an NFT to a self-financed address more than 25 times. There were several caveats, however. Chainalysis admitted that it cannot be 100% sure that these are NFT wash-traders. It also only analysed Ethereum wallets. Wash trading is just another scam to mislead the market and for thieves to steal money.
NFTs are unique, cryptographic assets and are different from cryptocurrency and digital currency. They represent real-world collectible items such as trading cards, artwork, videos, music, real estate and photos.NFTs have certificates of authenticity, which means they can’t be replaced. Each NFT is on a decentralized platform using blockchain technology. NFTs can also be used to represent an individual or business’s property rights, identities and domain name ownership. Because of the blockchain, NFTs cannot be copied or destroyed, so they can be used for several business applications — including supply chain, proof of ownership of product or service, and collectibles for loyalty.NFT wash trading is a type of scam. Wash trading is a misleading act to drive up the price of NFTs by the buyer and seller. The buyer and seller can sell the piece back and forth to drive up the cost, but only publicly report the first sale. In the next exchange, the money and NFT are returned to the original seller at the same time. Most of the time, the buyer and seller are the same bad actor.When the asset is sold, it goes to a new cryptocurrency wallet that the original owner also controls. NFTs are easy to link with the trading platform because users simply connect their wallets — sometimes without needing to identify themselves.
The price of NFTs then increases because future buyers feel it is in demand with all the sales. Cryptocurrency is valued the same way — by demand.
Blockchain analysis is one way to check the sale of NFTs to look for those that are self-financed for wash trading.
Why do people wash trade NFTs?
There are two main motives behind wash trading in the NFT space.
Type 1: To earn platform rewards
Some NFT marketplaces, like LooksRare, reward active users by giving them returns (in the form of the protocol’s token) based on their trading volume. Wash traders take advantage of this and maximize their rewards by generating unrealistically large amounts of trading volume. In turn, this can easily deceive users who want to analyze NFT collections or marketplaces in terms of liquidity and volume.
Type 2: To create an appearance of value or liquidity
To create a false sense of liquidity and an inflated value of a specific NFT collection or asset, some unscrupulous creators turn to wash trading to deceive buyers. They profit when genuine buyers are tricked into buying an NFT from them at a pumped-up price. This type of wash trader hides their activities with new wallet addresses that are self-funded from central exchange wallets. This type of wash trading generates a relatively small volume, which is not as disruptive to the market as Type 1 wash trading.
How to detect wash trading
A few analytics platforms out there, Forta detection bot one of them, do their detection and followed their logic. Their methodologies are somewhat similar, to be honest. Along with my own knowledge and analysis, here is a checklist of suspicious data and activity that should trigger any prospective NFT buyer’s alarm bells:
Here is the simple diagram how wash trade are happen.
Here, you can see that the NFT appears to have been sold in a straightforward transaction between the marketplace and the buyer. But closer inspection shows that the “buyer” wallet actually received the purchasing funds from the seller wallet – the same person is behind both. There are a couple of things you should be looking out for.
In the sales history of the NFT, if the same wallet address has purchased the token more than once this is a pretty good indicator that sales manipulation might be at play, and can be seen on the interface of marketplace itself.
How Does it Work?
The basic mechanism of NFT wash trading involves buying and selling NFTs between multiple accounts at artificially high prices, creating the impression of high trading volume and price appreciation. This is often done on decentralized marketplaces where anyone can buy and sell NFTs without central oversight or regulation.
– A group of individuals creates multiple accounts on a decentralized NFT marketplace.
– They then use these accounts to trade NFTs among themselves at artificially high prices, creating the impression of high demand and trading volume for those NFTs.
– As a result, other buyers are attracted to the market and start purchasing the NFTs, driving up their prices even further.
– The wash traders then sell their NFTs at the inflated prices, realizing significant profits.
The negative effects of wash trading extend far beyond the individual sale, and can be seen and felt in a couple of different places in the NFT space.
It doesn’t take a rocket scientist to understand that NFT buyers are negatively impacted by wash trading – imagine buying a hot token for a couple of Eth after carefully researching its history, only to find it’s not really worth much at all. For the individual, wash trading is a raw deal, which is why DYOR and knowing the tools available to help you is so important.
And the impact goes beyond just the buyer: genuine artists in the NFT space are also relying on the data within their NFT smart contracts to track their reputation and credibility over time, a process based on transparency. With bad actors taking advantage of this vector, smart contract history data loses credibility over time, damaging genuine artists.
Crypto is a nascent marketplace many people are still uncertain about entering, and scams of this nature further suppress its credibility. So although one wash trade might not seem like much, its existence means people are less likely to trust NFT valuations going forward, or simply not engage with the space at all.
Example of Wash Trading