News last week of the first ever seizure of NFTs by the UK tax agency in response to suspected tax fraud was a sign that last year’s booming NFT economy maybe running into some roadblocks in 2022. While recent data show that trade in NFTs rose from $106 million in 2020, to $44.2 billion in 2021, it’s a sign this meteoric rise is attracting the attention of authorities. And in the US, following reports of insider trading in NFTs and price manipulation, crypto-related crimes are the focus of a new National Cryptocurrency Enforcement Team. While there has been a lag in enforcement, as criminal and tax enforcement authorities struggle to play catch up, it’s clear cases of fraud and market manipulation in the crypto market are likely to hit the headlines in ever growing numbers in 2022.
Just last month it was reported that OpenSea NFT marketplace rival LooksRare was experiencing significant wash trading as some traders were taking advantage of its token-based rewards system. LooksRare gives away its own LOOKS token to users who trade in specific collections, worth over $12 million a day back in January. What raised suspicions was the trading back and forth of NFTs for inflated prices, which appears to have been motivated by a desire to boost the share of trading rewards. “Such wash trading tactics to manipulate token rewards distribution may not be illegal, but it’s distorting the data coming out of the marketplace,” argued Andrew Hayward in Decrypt. “LooksRare can tout figures that show significantly higher trading volume than OpenSea, but when the bulk of the top transactions appear to have been executed purely to game the system, the data holds little value,” he added.
The problem of wash trading in NFTs is a critical problem, both for the industry at large as well as for individual investors who want to invest in this exciting asset class without fear of fraudulently inflated prices. The practice of wash trading is when someone both buys and sells the same NFT or cryptocurrency to give the impression of greater trading volume, creating an impression of greater demand; this in turn helps inflate the NFTs price and attractiveness to buyers. In a recent investigation into this practice blockchain experts Chainalysis discovered that 262 NFT sellers had conducted more than 25 times to a self-financed address, in other words wash trading. While more than half the wash traders made a loss, by paying more in gas fees than they made, the investigation found that, “110 profitable wash traders have collectively made nearly $8.9 million in profit from this activity. Even worse, that $8.9 million is most likely derived from sales to unsuspecting buyers who believe the NFT they’re purchasing has been growing in value, sold from one distinct collector to another.”
Of course, market manipulation is wider than the NFT market, and in a relatively unregulated environment this has the tendency to increase the volatility of the market, affecting market sentiment and pricing. Although in principle cryptocurrency and tokenized assets rely on decentralized networks, the dangers of crypto criminal activity force regulators to monitor the crypto sector. Indeed, the market is still so easy to manipulate that even a tweet by a famous influencer. While Matt Damon’s ‘Fortune Favors the Brave’ crypto ad was widely mocked on social media, it underlines the power of celebrity endorsement in the space which shows no sign of changing. In the recent Super Bowl leading marketplace Coinbase spent close to $14m on a simple bouncing QR code-based ad, but the remainder drew heavily on celebrity endorsement, from LeBron James giving advice to his teenage self to comedian Larry David satirizing the fear of missing out in an FTX ad. It’s true the core appeal of NFTs going forward is the way it enables a direct relationship between fans and celebrities, the power of celebrity is also ripe for exploitation.
Within the wider cryptocurrency market, regulators are increasingly focusing on this kind of market behavior with recent warnings to retail investors in Singapore. While the FCA in the UK is currently consulting on concerns about “the ease and speed with which people can make high-risk [crypto] investments by proposing a significant strengthening of its rules on how high-risk financial products are marketed.” Sarah Pritchard, Executive Director of Markets at the FCA, explained the thinking behind the current action in preparation for the UK Government bringing the promotion of crypto investments under the FCA’s remit: “Too many people are being led to invest in products they don’t understand, and which are too risky for them. People need clear, fair information and proper risk warnings if they are to invest with confidence, which is the central aim of our consumer investments strategy.”
Typical market manipulation strategies:
Pump and dump
Pump and dump refer to an individual or a group pooling funds to inflate a token and profit from the price growth, by selling a token once it has attracted the attention of other investors, at an inflated price. While so-called ‘pump and dumps’ have made a lot of money for a few people, the causalities are new investors who are unaware of what is going on are more likely to fall victim and lose their money.
Wash trading
As outlined wash trading is the practice of buying and selling a NFT or token asset to yourself to inflate its volume, which in turn attracts attention and helps inflate prices. There are numerous instances where unregulated exchanges or crypto traders use this method by trading a token in huge volumes for its value to receive attention, distorting the market even further and benefiting the manipulators.
Spoofing
This strategy was prevalent, particularly in the early days of cryptocurrency, and it is still used on small, unregulated exchanges. The approach involves placing a huge order to generate create fake demand. Essentially, the order can influence a bullish or bearish sentiment to the favor the fraudulent trader. Typically, they will place big sell orders to trick novice investors into panic-selling, before removing their sell order and acquiring tokens at a lower price.
How to best avoid market manipulation
The best advice to crypto investors is to conduct thorough research to avoid falling prey to manipulated cryptocurrency projects. You can also cross-check all information about a token to verify and fully understand the factors behind an asset’s movement and price action. Furthermore, traders can make informed selections by sticking to making decisions based on longer term trends rather than recent bias. It’s also critical for you to diversify your portfolios to protect yourself from unforeseen market manipulation, as the likelihood of market manipulation affecting all your crypto assets is low. And to bear in mind that the lower the volume of certain coins is makes them easier to manipulate.
The cryptocurrency market is risky like any other asset trading market. The downside is that continued market manipulation is prompting regulators to step up their efforts to monitor the cryptocurrency market. However, with big money to be made market manipulators will seek to conceal their actions, so investors still need to educate themselves on how to detect and deal with these issues. Within the industry cryptocurrency exchanges are taking the initiative, for example with the recent launch of the Crypto Market Integrity Coalition, to help combat fraud and promote public and regulatory trust. BigONE Chairman Anndy Lian said that in terms of NFTs there needed to be a common industry standard to ensure both ownership and copyright. “I always encourage everyone in crypto to work hard for their holdings. Shill properly, ethically, and smartly. It is a fine line between good shill and spam. My motto is ‘respect everyone’. This is my way of life. But when I see a scam, I will point it out. At the end of the day, it’s a shared responsibility between crypto community members and the teams behind crypto projects.”
Original Source: https://www.securities.io/market-manipulation-in-the-cryptocurrency-industry/
