Ever get the feeling you’re missing out on the next big thing? Does an NFT drop or meme coin look too good to be true?

We all know what that means. But this one just might be different…

FOMO is common in crypto and other investment spaces because nobody wants to miss out on a 100X asset or a brilliant new platform. However, classic financial schemes are still more prevalent in the crypto space than you’d imagine.

Given the market’s volatility, it is important to understand a few basic concepts before aping into a new project.

Let’s Talk About Wash Trading. 

Here’s an example: Imagine starting an NFT project and increasing the floor price. The first step is setting up multiple funded wallets to mint and sell those NFTs. Afterward, this network of wallets can trade and sell between themselves, increasing the price.

Now, when someone outside of my network of connected accounts sees the NFT project on OpenSea, they find that there’s already been 200 ETH worth of transactions in a few days. It’s gone from a cost of 0.05 ETH at mint to a whopping 1.5 ETH. But anyone who buys at this point will be left holding onto an NFT with an artificially inflated value.

It is illegal when this occurs in the larger finance world, but crypto is a lawless domain, and you just overspent for an NFT.

How common are these schemes across centralized exchanges, NFT projects and alt tokens?

Wash trading accounts for more than 75% of trades on many cryptocurrency exchanges. Chainalysis meanwhile found that wash trading in NFTs has generated almost $9 million in the past year. Meanwhile, 87 percent of trades on a new NFT platform called Looks Rare were marked as wash trading, amounting to a whopping $8 billion; this illicit strategy allowed traders to earn more rewards through the process.

Yes, there are ways for you to make smarter investments by identifying projects that show potential wash trading. You don’t need a strong economics background or any coding experience to do this either. Once you know what to look out for, you can ensure the safety of your investments.

 

Be wary of any NFT , Meme or Altcoin if you’re tempted to ape into it.

Crypto Exchanges that Pump their Volume

Here’s another example:
Suppose you see a new exchange that you’re a little uncertain of touting an unusually high Bitcoin and Ethereum trading value. You wonder if there’s something more to it and decide to make an account and see how it works. Later, you find out that 90% of this trade volume was artificial, insiders facilitating trades by themselves to get more people aboard the platform.

Pumping up the volume through this process, aka wash trading, allowed the platform to grow and attract customers who are more than happy to pay the trading fees.

Yes, this story happened in Canada – a company called CoinSquare conducted around 840,000 of these trades to pump their volume at the end of 2018 and early 2019.

But this is just an isolated example, right?

Nope.

Which Exchanges Can You Trust?

Researchers at the SEC investigated the Bitcoin market across 83 different exchanges to look for signals that indicate wash trading through artificial bots created by the exchange or individual users. To do this, the authors created trade size histograms to visualize how often people trade different amounts of Bitcoin.

Below are a few examples of what we would expect from exchanges with legitimate trading volume taken from the report.

From the Report:
Economic and Non-Economic Trading In Bitcoin: Exploring the Real Spot Market For The World’s First Digital Commodity

Two things pop out – first, most traders buy and sell small volumes and second, there are spikes at round numbers like 1 or 2 BTC (compared to 1.32 BTC).

It is expected that we see a certain amount of activity from whales, but it shouldn’t dominate the proportion of trades.

Below are a few histograms that violate some of these assumptions from the less-than-reputable exchanges.

OKEx does not show the behavioural spikes at round numbers, while TideBit doesn’t have a complete distribution (i.e. people trading low volumes and people trading very high volumes).

Another critical point is that the volume varies over 24 hours. It is normal to have ten times as much trading during the middle of the day than at 3 in the morning.

But many exchanges don’t have this natural variance in volume throughout the day or even show patterns indicating that similar amounts of trading occur throughout the day.

Below are some examples from the report violating this variance.

Finally, the authors can then look at the spread.

Bitcoin has a very efficient spot market, meaning that there is a tight spread between the bid/ask price of the asset. Most of the spread on exchanges like Coinbase ranges between $0.01 to $3 with brief, occasional spikes to about $12.

Other exchanges show unrealistic spot trading where the bid/ask spread is abnormally high, even over $100.

73 of these exchanges showed signs of market manipulation for Bitcoin volume, accounting for around 95% of the spot trade volume.

Here’s the list of exchanges without Bitcoin wash trading (from 2019):

  • Binance
  • Bitfinex
  • Coinbase Pro
  • Kraken
  • Bitstamp
  • BitFlyer
  • Gemini
  • itBit
  • Bittrex
  • Poloniex

A more recent analysis found that there are also wash trading issues across many other cryptocurrencies, including Ethereum.

The Problem:
Wash trading appears to be the norm at many less-reputable exchanges:

The Solution:
Avoid exchanges that don’t have strong reputations. If the ask/bid spread is abnormally high, you’ve got yourself another red flag.

Wash Trading NFTs

The current centralized nature of many NFT exchanges enables and even speeds up the wash trading of different NFT assets.

Crypto Punk 9998

On October 28th, 2021, CryptoPunk 9998 sold for more than $500 million.

As one of the first significant projects in the NFT space, it is considered to have historical value – but $500 million!?

Not so fast.

It turns out that the original buyer used flash loans to get the funds for the purchase. After the purchase was complete, the seller sent the Ethereum back to the buyer who repaid their loans.

The NFT was sent back to the original buyer, who then listed it for $1 billion. The buyer and seller (if the addresses even belonged to different individuals) colluded to pump the price of the CryptoPunk. Luckily, these transactions are captured on Etherscan, allowing anyone to view the transactions from both the buyer and the seller.

Additionally, many NFT projects have anonymous or pseudonymous founders. There are more than 400,000 wallets that hold NFTs, but it is unclear if multiple wallets belong to the same individuals. Take the case of the Bored Ape Yacht Club founders; they are likely very interested in the NFT space, so we would expect them to own multiple different kinds of NFTs. But their wallets were created specifically for the launch.

It’s unclear if any of these creators have other wallets to inflate trade volume and price further. Additionally, it’s unclear when some projects begin associating with celebrities. One person can pay a celebrity $3 million to buy an NFT for $2.5 million and later return it or re-sell it for a higher value. It is incentivized because NFT tracks and ranks NFTs based on overall volume and weekly activity.

The best piece of investment advice for avoiding overhyped, overpumped, and wash traded NFT assets is simple: Be suspicious if lots of celebrities are promoting or buying into a relatively new project. If a project rises meteorically, are their creators doxxed, do they have an established track record?

Wash Trading Alt Coins

According to some preliminary research, wash trading occurs for more than 30% of tokens on two decentralized exchanges investigated by researchers. Future research in the space will likely identify that a lot more tokens are subjected to this kind of activity. In that case, how do you choose which decentralized exchange to use and whether a token has real volume? And how much does this artificial volume contribute to the overvaluation of specific assets?

Here are a few points to consider before investing in an altcoin that seem like it’s bordering on “too good to be true” territory:

  • Go back to the whitepaper – is it technically robust, and does it make sense?
  • Are the developers doxxed, and do they have experience and success in the space?
  • How large is the Twitter/Telegram/Discord community, and does it reflect the number of unique addresses holding the tokens?
  • Look for criticism and FUD: ask yourself if any of this criticism makes sense.

Takeaways

Wash trading isn’t just a word thrown around by crypto critics to generate distrust.

It is a real phenomenon that can artificially pump the price or trade volume of different tokens and assets.

It means buyers will end up overpaying. And if the creators rug-pull or abandon the project – they’re left holding the bag.

If you buy an NFT that’s been wash-traded, chances are you won’t be able to make your money back when you sell it.

Being financially literate and understanding these concepts are important to avoid these scams and ensure you make better investments.

Avoid new exchanges. Especially exchanges with alarmingly high trade volumes or margin spreads.

If it seems to good to be true, it probably is.

Especially in crypto.

Be wary of any NFT and Altcoin that you’re tempted to ape into.

Assess the risk first, do your research into the team and the community and worry about FOMO later. Or not at all.

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