NFT Markets Cross $44.2b in 2021, But With Rampant Wash Trading
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NFT Markets Cross $44.2b in 2021, But With Rampant Wash Trading

CryptoSlam and Chainalysis shine a light on NFT fraud.
Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policy prior to making financial decisions.

The non-fungible token (NFT) market reached new heights in 2021 and multi-million dollar sales became common headlines. Even though the broader cryptocurrency market had a rough start to the year, OpenSea recorded the highest monthly trading volume ($3.5B+) in January 2022 and ~$44.2b poured into the growing market last year.

With so much value in the mix exchanging hands so quickly, some wonder if this is more about tax evasion or money laundering, instead of genuine art.

Last week, IRS CI (Criminal Investigation) agent Kroner said as much, noting that NFTs are ripe for fraud. However, this is nothing new for the art world, except that the medium of exchange has evolved.

NFTs – Same Scam, Different Medium?

Physical art galleries have been known for decades as ideal vehicles for money laundering. Art inherently has subjective value so a price tag can be arranged between interested parties. Such a process can be summed up in a few steps:

  • Buyer A has $1 million dollars, ready to purchase a notable piece of art.
  • The artwork is transferred to freeport for storage, which is a designated, lightly taxed zone to encourage economic activity.
  • Buyer A then sells the artwork to buyer B at the same location, with $1 million legitimized.

In the pre-2020 period before the lockdowns, the IMF reported that illegal art trafficking accounts for $6 billion annually, of which half can be attributed to money laundering. It is then easy to picture how digital, blockchain-encrypted NFTs would pose a drastically more significant challenge to authorities.

Courtesy of Chainalysis, we can quantify that picture.

$44.2 Billion Poured into NFT Smart Contracts in 2021

As you know, tokens are smart contracts that have many purposes. Regular fungible tokens serve as economic units, grant voting and governance rights, following the ERC-20 smart contract standard. NFTs, being non-fungible, follow the ERC-721 and ERC-1155 standards instead.

The latter is a newer hybrid smart contract, allowing for multiple fungible and non-fungible tokens, and can be transacted in batches. Accounting for both types, ERC-721 and ERC-1155, the NFT market saw an influx of $44.2 billion worth in crypto assets during 2021. This represents a massive 416x increase from 2020.  

Source – Chainalysis

Luring NFT Investors with Wash Trading

If you’ve ever wondered how it is possible that so many NFT traders emerged in such a short time, then wash trading should suffice as an explanation. This is an age-old market manipulation in which the buyer is also the seller. By buying and selling the same asset, one creates a false market activity impression.

This is especially important for NFTs because most buyers would eventually want to make a profit from a resale. However, because NFTs are speculative, illiquid assets, that potential resale entirely depends on the demand, i.e., the market’s liquidity. For this reason, wash trading has been rife in the NFT marketplaces.

Source – Chainalysis

By analyzing self-financed NFT addresses, Chainalysis accounted for  $8.87 million in profits from wash trading. However, not all wash trading sticks. Out of a total of 262 NFT addresses analyzed, 152 were unprofitable, accruing a $416.9k loss. Interestingly, although illegal in the stock market, wash trading has not yet been legally prohibited for blockchain assets.

NFTs In Money Laundering

Money laundering is making illicitly gained funds legal, so IRS, or other law enforcement agencies, don’t ask any questions. Digital assets are perfectly aligned to grow this underground industry. However, with the exception of privacy coins such as Monero (XMR), blockchain also allows for transparency.

In fact, this makes illicit flows on blockchains more quantifiable than on seedy freeports. Chainalysis employed its tracking tools to derive the following breakdown of this activity.

Source – Chainalysis

Compared to wash trading, NFT marketplaces saw minor traffic coming out of criminal activities. To be reborn as NFTs, only $1.4 million can be attributed to money laundering. Scams make up the bulk of criminal activity, sharply rising from Q2 to Q3 2021. In contrast, Q4 2021 saw a drastic rise in traffic coming from a sanctioned platform, at $284k.

The prohibited platform, deemed so by the Department of Justice (DOJ) and U.S. Treasury’s Office of Foreign Asset Control (OFAC), is Chatex. This is a peer-to-peer (P2P) crypto exchange service similar to LocalBitcoins. However, it operates as an automated Telegram bot, eschewing all KYC/AML protocols.

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NFTs Continue to Ignore Crypto Headwinds

With the downturn of the crypto market in January, led by Bitcoin’s over 20% drop, NFTs are powering through the so-called crypto winter. According to the Block research, January churned up to $6.86 billion in NFT trading volume, which is a 3x increase from December’s $2.67 billion.

Source – CryptoSlam’s NFT Global Sales Volume Index

Surprisingly, the bulk of that volume didn’t come from OpenSea, the dominant NFT marketplace, but from LooksRare. After launching on January 10th, the new NFT marketplace accrued nearly $2 billion in trading volume. Just like Rarible has its RARI token, LooksRare has its own LOOKS token used for governance, allowing people to earn rewards every time they trade.

However, LooksRare is also rife with wash trading, according to CryptoSlam, the NFT analytics platform.

Despite this massive reduction in fake traffic, NFTs continue to diverge from the crypto market as their own niche asset class. Moreover, it appears that NFTs are much more difficult to use for malfeasance than one would think at a first glance.

From wash trading to money laundering, blockchain transparency is likely to make criminals and scammers think twice before placing their hopes in the emerging market.

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Did you know that you can track down every NFT smart contract on EtherScan, ensuring your prospective purchase comes from original NFT publishers?