Wash trading happens when a trader or investor buys and sells the same asset several times in a short period of time to mislead other market players about the price or liquidity of an asset.
“Wash trading” is a market strategy used by traders to impact an asset’s trading activity and price. Typically, one or more cooperating agents execute a series of deals without considering account market risks, resulting in no change in the hostile actor’s initial position.
Wash trading may be motivated by a variety of factors for a trader or company. For example, the goal is to manipulate asset purchases. Be it raising the prices or lowering it.
What is the process of wash trade?
The goal of the parties participating in the wash trade is to raise capital to further support business activities and expansion of their companies. It can only be successful if the intent of participating parties as well as the outcome of such a transaction is the same which allows wash trading to serve its purpose.
When an investor buys and sells tokens of the same asset at the same time, this is known as a “wash transaction”. The definition of wash trades, on the other hand, goes a step further by considering both the investor’s purpose and the outcome of the transaction.
A trader’s motives should be connected to wash trading. They should have acquired and sold assets with common beneficial ownership in a short period of time. Accounts owned by the same person or entity are referred to as “beneficial ownership”.
Trades between accounts with common beneficial ownership may be of interest to financial authorities since they may suggest wash trading activity. On the other hand, wash trades do not always have to entail actual transactions; they can also occur when investors and dealers seem to perform the transaction on paper but no assets are swapped.
Why is it prohibited to engage in wash trading?
Traditional finance forbids wash trading. However, in the decentralised world of non-fungible tokens (NFTs), the legality of wash trading has yet to be resolved.
Despite the lack of regulation and categorisation for NFT, several governments have taken a stand against it. Even if crypto wash trading is illegal in some places, the decentralised nature of cryptocurrencies makes it impossible to identify the perpetrators. In contrast to traditional financial instruments such as equities, which have verified Know Your Customer criteria, blockchain-powered assets can be traded anonymously, posing the danger of wash trading.
The risk emerges as a result of deceptive price and volume information, which cannot be avoided until authorities decide which country is in charge of overseeing cryptocurrency.
Why is wash trading an issue in the NFT space?
NFT wash trading is an issue for investors, the global community, collectors, and traders since these individuals influence the price of an asset using less liquid NFTs.
Due diligence has gotten more difficult as investors have been compelled to rely on quantitative statistics, which has resulted in poor investment judgments. Discrepancies in data must be evaluated by professionals to stimulate NFT investments and avoid NFT scams. Furthermore, NFT crimes disproportionately affect the NFT community. Wash trading can now be used by regulators and proponents of mainstream financial services to oppose decentralisation.
When new coins are presented on the market, they have no price or volume history. Developers or other insiders may engage in “wash trading” to fool participants about the actual value of the currency. Therefore, avoid investing in such initiatives. Furthermore, many NFTs have little or no trading volume or investor interest. NFT owners may easily engage in wash trading to persuade gullible buyers to acquire the NFT at an inflated price. Avoiding freshly issued small-cap cryptos and NFTs is the most important way to avoid wash trading.
To prevent being a victim of wash trading, a trader should select more established cryptocurrencies with higher volume. The larger the market, the more fraudsters will be required to control it. For example, previously established cryptos like Bitcoin (BTC) or Ethereum, which are valued at hundreds of billions of dollars, make crimes such as wash trading extremely difficult.
