Market Manipulation Chatter Rises as Digital Art Scene Explodes
Digital assets are booming, with buyers paying up for so-called NFTs that give them exclusive ownership of electronic tchotchkes.
(Bloomberg) -- A digital artwork by Beeple set auction records Thursday when it sold at Christie’s for a mind-bending $69 million. Twitter Inc. co-founder Jack Dorsey is auctioning the non-fungible token for the first tweet ever, “just setting up my twttr,” with the highest bid coming in at $2.5 million, so far. LeBron James highlights are fetching six figures.
If you were somehow unaware, digital assets are booming, with buyers paying up for so-called NFTs that give them exclusive ownership of electronic tchotchkes. Explanations for why, say, a GIF of a cat with a rainbow trail commands a king’s ransom aren’t hard to come by. The more prosaic theories say the price per pixel is surging as Bitcoin and other cryptocurrencies mint new millionaires every day and those newly rich digital natives look to spend in their adopted domain. And sure, it could be as simple as a good old mania around the latest shiny object that’s caught people’s attention.
But there’s also a nefarious suggestion popping up on message boards, Twitter and blogs that attributes at least some of the rise in prices to wash trading. That’s when a trader or group of traders buy and sell the same asset to create the illusion of heightened demand.
The claim is hardly new: Wash trading has been called “crypto’s open secret” and concerns about its prevalence have dogged the space for years. The U.S. Securities and Exchange Commission in a 2019 response to an application for a Bitcoin exchange traded fund cited “fraudulent and manipulative activity” in the market as grounds for rejection.
In a world where identities are abstractions with 30 or so alphanumeric characters representing some hidden person’s digital wallet address, claiming wash trading is at once plausible and yet nearly impossible to prove. Except for the most brazen of acts where two accounts repeatedly trade back and forth with each other, identifying self dealing requires forensic accounting tricks like employing Benford’s law or analyzing trade size distributions by how they fit with established mathematical principles like Pareto-Levy.
“Crypto exchanges today are not regulated as much as regular exchanges where wash trading is clearly prohibited by regulators,” said Matthieu Soule, head of BNP Paribas C.Lab Americas, the bank’s innovation workshop. “That means that today’s investors have to trust the platforms where they are transacting on to prohibit and monitor such wash trade practices.”
For its part, Nifty Gateway, one of the largest NFT exchanges by volume, says that it keeps watch for questionable transactions on its system.
“To date we haven’t seen any evidence of wash trading on our platform, and we do monitor sales for abnormal activity,” a spokesperson for Nifty Gateway wrote in an email. “The majority of our customers purchase Nifties with credit cards, which require them to provide some personally identifiable information, and limits the risk of wash trading.”
Still there are signs that there’s some truth to the tale of the wash trading boogie man.
In a clear-cut case, analysts at NonFungible.com identified a Blockchain Cuties character that two accounts traded back and forth with each other over the course of a day.
More extensive research has been done by two groups of academics focusing on cryptocurrency exchanges. While neither looked specifically at NFT markets, they both believe their research is applicable and that the illicit transactions may be present there as well.
Will Cong, an associate professor at Cornell University’s SC Johnson College of Business and one of the authors of a paper that claims to have detected abnormal trading patterns on unregulated cryptocurrency exchanges, said that he didn’t see a major difference between the incentives to wash trade in currency and NFT markets.
“Fraud detection is hard,” said Cong. “Even if they are all non-fungible, they’re still anonymous and it would be hard to track down market manipulators.”
In another study, two researchers from the Technical University of Berlin wrote that decentralized exchanges where many crypto assets and tokens trade are “prone to manipulative behavior.”
“Every interaction happens on chain and they’re done with some account that is virtually cost free to create,” said Friedhelm Victor, an author of the Berlin paper. “It’s really easy to create multiple accounts and trade with yourself.”
But Victor cautions that high transaction fees on the Ethereum blockchain make wash trading a losing proposition.
“Right now it’s so expensive to execute a transaction, for the fungible tokens it’s probably not attractive to do this right now,” said Victor. “That might change in a bear market” or as upgrades to the Ethereum blockchain which will make it cheaper to transact roll out.
Victor’s sentiment is echoed by Tom Robinson, chief scientist and co-founder of Elliptic, a blockchain data tracker.
“Wash trading of NFTs is unlikely because trades are taking place on transparent, public blockchains for everyone to examine,” said Robinson. “In addition, transaction fees on blockchains such as Ethereum are very high, making such activity prohibitively expensive.”
©2021 Bloomberg L.P.