when market manipulation affects NFTs

Marketplaces with distorted transaction volume, pools with high prices, the NFT market still has to deal with questionable practices.

In the traditional financial sector, market manipulation consists in carrying out operations whose consequences will distort the information intended for the actors in the ecosystem. In a regulated sector, this type of practice is prosecuted.

The NFT market, still nascent and above all largely decentralized, is not under the supervision of an authority, at least for the time being. Lack of regulation means an increased risk of manipulation.

This is done in different ways, either by the marketplaces themselves, or by the creators or even by the users.

NFT Marketplaces, Victims or Responsible?

Dominated for several years by the OpenSea platform, born in 2017, the NFT marketplace activity has been driven by the emergence of many players, especially during the last two years with the arrival of Rarible (2020), Magic Eden (2021) , Looks Rare and X2Y2 (2022).

In this competitive sector, some therefore go through suspicious processes to stand out, in particular the use of wash trading, that is, the artificial creation of transactions to inflate the volume of exchange and thus the activity.

Recording of the X2Y2.io website. © JDN

“We first had the case with Rarible, that was the first example,” confides Gauthier Zuppinger, co-founder of the analytical site NonFungible.com and author of a conference entitled “The Truth About Market Manipulation” at NFT. London. “Subsequently, we saw LooksRare, X2Y2 lend themselves to this. The latter is one of the biggest examples with over $500 million a month in wash trade. By 2022, we saw 12% of the trades in the market correspond to wash trade. That’s significant enough to to obscure the reading of a market.”

It is important to clarify that trading in NFT marketplaces is an open secret, the presentations of another data agglomeration site Dune.xyz also confirm the words of the head of NonFungible and even present marketplace assessments that exclude suspicious transactions.

Among the main interested parties, the development manager of X2Y2 does not deny the presence of washtrading, but disputes the responsibility of the platform. “It’s not something we support,” Derek Caussin replies. When we compile our monthly statistics internally, we publish the figures ourselves without washing trade. Simply put, our protocol is designed to reward the most active, and traders are abusing it.”

This is actually another explanatory factor for wash trading: some platforms like Rarible, LooksRare and X2Y2 have created their own token, which is mostly used as a reward to encourage transactions on the platforms. In fact, some users generate tokens by performing transactions around the same assets.

“Pay for Trade Encourages Wash Trade”

“This is the most common case,” said Gauthier Zuppinger. “It pays very, very well. This reward mechanic, pay to trade, encourages laundry trading.”

According to the analyst, one of the most obvious patterns is that of repeated transactions between two wallets, usually owned by a single holder. Nevertheless, the current models would become increasingly complex with dozens of portfolios and assets involved, making the task for observers particularly difficult, if not impossible for a neophyte.

“You need to look at the sales history. If you observe too much recurring activity, an always the same transaction value, or wallet addresses that appear too often, there is probably something strange. Nevertheless, this is increasingly complex for an untrained user to arrive at on a marketplace and try to understand on your own what’s going on. It takes a lot of time and you have to deal with a huge amount of data”, gushes Gauthier Zuppinger, whose team does not depend on the APIs of the marketplaces, potentially distorted, but on the direct analysis of the activity of blockchains.

Creators of NFT sometimes work responsibly

NFTs now number in the millions on a growing number of networks like Ethereum, Polygon, Flow, Tezos, Immutable X, Wax, etc. A jungle where creators also need to stand out. In fact, some employ a strategy similar to that of marketplaces by artificially inflating the price of their collection. All you have to do is create larger and larger transactions around the same asset or a whole collection. “In summary, a user will trade himself an NFT for the price of several ethers (one ether is worth about 1160 euros as of November 16, 2022, editor’s note) to raise the price and give it visibility”.

And thus exploit the liquidity of an inexperienced collector.

By 2020, NonFungible.com was already talking about obvious cases, from Cryptokitties to certain assets in the Decentraland metaverse.

Although zero risk does not exist, there are signs that best protect against falling into the trap of artificially stimulated value NFTs:

  • In this growing sector, the creators of NFTs are less and less anonymous. Without it being a rule, an unidentified creator poses an additional risk.
  • As far as possible, it must be verified that the smart contract at the origin of the NFT has been audited. Although not foolproof, verification tokens exist on some marketplaces, and explorers like Etherscan (for the Ethereum network) have also implemented it for certain types of assets.
  • With collectibles, it is important to check how widely the collection is distributed. The OpenSea platform now indicates the number of unique holders within the same collection. Too much concentration in the hands of a single collector is generally a bad sign.

Finally, common sense must prevail. Although the method is once again not perfect, online verification of an artist’s or team’s history is important, and one must always remember that NFTs likely to reach a high valuation are not the most frequent: according to the firm Nansen , of the 29,000 collections posted on Ethereum between 1eh January and June 30, 2022, two-thirds raised less than 5 ether.

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