Wash trading and money laundering in NFTs: What’s the difference?
Wash trading and money laundering in NFTs are fraudulent activities that manipulate market prices and facilitate illegal financial transactions in the digital art world.
As non-fungible tokens (NFTs) continue to shape the digital landscape, offering creators new ways to monetize their work, they have also drawn attention from those with malicious intentions.
Two of the most concerning fraudulent activities in the NFT space are wash trading and money laundering. These practices are illegal and undermine the integrity of the NFT market by artificially inflating prices and introducing illicit activities that can have serious financial and legal consequences.
However, they have different purposes and methods of operation. Let’s break down each practice.
Wash trading
- Meaning: Wash trading is a method used to deceive the market by artificially inflating the demand and value of an NFT through fake transactions. The purpose is to manipulate the perceived worth of the asset without any real exchange of ownership.
- How it works: The person executing the wash trade buys and sells the same NFT back and forth between different wallets they control, creating a false sense of market interest.
- Objective: The goal is to mislead buyers into believing that the NFT is more valuable than it truly is. Once the perceived value is inflated, the NFT is sold to an unsuspecting buyer at an elevated price.
- Impact on the market: Wash trading can create artificial market movements, mislead potential buyers, and inflate prices without real demand. Although it doesn’t necessarily involve the use of illegal funds, it distorts the market.
Money laundering
- Meaning: Money laundering in the NFT market refers to the process of disguising illicit funds as legitimate income by purchasing NFTs with dirty money and then reselling them to “clean” the funds.
- How it works: Criminals acquire NFTs using illegally obtained money, and after reselling the NFTs, the funds appear legitimate. They may transfer the NFTs through different wallets or platforms, further hiding the trail.
- Objective: The primary goal is to hide the source of illegal funds, making them appear to be from a legitimate source by involving NFTs in the transactions.
- Impact on the market: Money laundering does not directly manipulate prices, but it exposes NFT platforms to significant legal and regulatory risks. It’s a financial crime that can tarnish the reputation of the entire market.
While wash trading is designed to manipulate prices, money laundering leverages NFTs to launder illicit funds. Both pose significant threats to market transparency and the broader financial system.
Here’s a quick summary of how wash trading NFTs is different from money laundering:
The process of wash trading in NFTs
Wash trading in NFTs involves inflating prices through repeated transactions between controlled wallets, misleading buyers and distorting the market.
Wash trading in NFTs works as follows:
- Initial purchase or creation of the NFT: An individual or group acquires or mints an NFT on a marketplace or blockchain platform.
- Selling the NFT to themselves: The individual then sells the NFT to a different wallet they control or a collaborator’s wallet, usually on the same marketplace. This repeated back-and-forth transaction increases the trading volume, creating an illusion of demand for the NFT.
- Artificial price increase: Through these repeated transactions, the NFT’s price gradually increases. New buyers, noticing the sudden surge in value, may believe that the asset is in high demand and rush to purchase it.
- Final sale at inflated price: After the price has been inflated through multiple cycles of trading, the wash trader sells the NFT to an unsuspecting buyer, often for a significantly higher price than the asset’s actual worth.
In October 2021, a CryptoPunks NFT, “CryptoPunk 9998,” was involved in a wash sale on Ethereum. It was sold for 124,457 Ether (ETH), but the funds circled back to the buyer, repaying the loan used for the purchase. This case combined a flash loan with NFT money laundering.
On April 5, 2022, Bloomberg reported that NFT tracker CryptoSlam data showed that wash trading accounts for $18 billion, or 95% of overall trade volume, on the NFT marketplace called LooksRare.
As seen from the above examples, the danger of wash trading lies in its ability to distort the market, creating false value perceptions and leading to potential financial losses for those who fall for the deception.
How criminals use NFTs for money laundering
Money laundering through NFTs is a sophisticated process that uses the decentralized nature of blockchain technology to disguise illicit funds.
NFTs can be used for money laundering due to their pseudonymous nature and the ease of transferring assets across borders. Scammers and operators such as Chatex (a Russia-based cryptocurrency exchange and Telegram bot) exploited NFTs to launder funds by facilitating illicit transactions, allowing them to hide the true origin of money through crypto assets. It was sanctioned by the US Treasury Department in November 2021.
Here’s how criminals typically use NFTs to launder money:
- Purchasing NFTs with illicit funds: Criminals use money obtained from illegal activities, such as fraud or drug trafficking, to buy NFTs. The anonymity provided by blockchain transactions makes it difficult to trace the source of the funds.
- Selling NFTs at inflated prices: After acquiring the NFTs, criminals sell them to accomplices or related parties at inflated prices. These sales make the proceeds appear legitimate, as they are tied to the NFTs’ supposed value.
- Layering transactions: To further obscure the source of the funds, the criminals might move the NFTs between wallets or sell them on different platforms. This obfuscation makes it harder for authorities to trace the money back to criminal activities.
- Integration of “clean” money: Once the funds from these transactions have passed through several layers of laundering, the “cleaned” money can be withdrawn, converted to fiat currency, or reinvested into other legitimate assets.
Regulations on NFT wash trading
The regulatory landscape for NFTs, especially in relation to wash trading and money laundering, is still in development.
While there are no universal regulations specifically targeting NFT wash trading at the global level, several overarching regulations apply to cryptocurrency markets and can impact NFT platforms:
- US Securities and Exchange Commission (SEC): In the United States, the SEC has started scrutinizing the digital asset market, including NFTs. While NFTs themselves may not qualify as securities, wash trading practices can fall under the SEC’s purview if they are deemed to mislead investors or manipulate the market.
- Anti-money laundering (AML) laws: Various countries, including members of the European Union, are considering more stringent Anti-Money Laundering (AML) laws concerning e-money tokens. However, NFTs are partially regulated under the Markets in Crypto-Assets (MiCA) regulation, with their inclusion depending on whether they meet specific criteria for uniqueness and non-fungibility. ESMA advises assessing NFTs individually based on their technical features and intended use to determine regulatory applicability.
- Financial action task force (FATF): FATF, a global regulatory body, has issued guidelines for digital assets, including NFTs. These guidelines encourage NFT platforms to implement Know Your Customer (KYC) procedures, monitor transactions for suspicious activity, and report unusual transactions to authorities. Specifically, FATF guidelines offer insights on when NFTs are considered virtual assets (VAs). NFTs are classified as VAs if used for payments, investment or become fungible.
Example of enforcement actions against NFTs
In 2023, the SEC accused Impact Theory, a media company focused on motivation and personal development, of selling NFTs that qualified as investment contracts under the 1946 Howey test.
The SEC argued that this created a reasonable expectation of profit based on the company’s efforts, making the NFTs securities. Another key factor in the SEC’s decision was the presence of resale royalties, where creators earn a percentage from future NFT sales.
Here are the key details:
- NFT sales and funds raised: Impact Theory sold 13,921 NFTs (Founder’s Keys) between October and December 2021, raising nearly $30 million in ETH from investors across the US.
- Marketing and promised perks: Buyers were promised exclusive benefits, including digital collectibles, discounted NFTs, and access to content, meetings and courses.
- SEC’s focus on investment claims: The company promoted its NFTs as an early-stage investment in a major media brand, emphasizing potential profits and comparing them to startup equity.
- SEC enforcement and refunds: In response to regulatory scrutiny, Impact Theory repurchased 2,936 NFTs, returning $7.7 million in ETH to investors.
Although regulations surrounding NFT wash trading and money laundering are still in their early stages, the increasing volume of transactions could prompt more comprehensive legal frameworks in the near future. As the market matures, the demand for clearer and enforceable laws will rise.
How to protect yourself from NFT fraud and illegal trading
Buyers and sellers can reduce NFT fraud risks by verifying creators, checking transaction histories, avoiding sudden price spikes, using reputable marketplaces and reporting suspicious activity.
Here are the steps that buyers and sellers can take to minimize their exposure to these activities:
- Verify NFT creators: Always ensure the authenticity of an NFT by verifying the creator’s profile. Many platforms offer verified profiles to help establish legitimacy.
- Examine transaction histories: Check the history of the NFT’s transactions. Repeated transactions between the same wallets can be a sign of wash trading.
- Be cautious of price spikes: If you see an NFT suddenly increase in price without any major external factors or marketing efforts, it could be a sign of market manipulation.
- Stick to reputable marketplaces: Use trusted platforms such as OpenSea, SuperRare and Rarible, which implement security measures and are less likely to engage in fraudulent activities.
- Report suspicious activity: If you encounter any suspicious behavior or transactions, report it to the platform or legal authorities of your jurisdiction to help maintain a safer marketplace.
Protecting yourself from NFT fraud starts with awareness and caution. Never trust hype alone — do your research, and if a deal feels too good to be true, it probably is. Report any suspicious activity to help keep the space safer for everyone. In the fast-moving world of NFTs and cryptocurrencies, skepticism is your best defense.
