When learning about cryptocurrency, one term to keep in mind is wash trading. In this video clip from "The Crypto Show" on Motley Fool Live, recorded on Feb. 23, Fool.com contributors Jon Quast and Travis Hoium outline this ongoing issue with NFTs and what investors should know about it.
Jon Quast: This was actually fascinating. It came up because in the news, Melania Trump, the former first lady, launched her own NFT project. This is ongoing. She's releasing various, if I'm not mistaken, one of ones. It's not like a 10,000 piece set like the Bored Apes, for example, but just one piece and then another piece that's unique and stuff like that. Raising money for charity, great stuff, but accused of making a wash sale.
Travis Hoium: Yeah. This would have been basically her buying an NFT that she was selling. We're still seeing your screen there, Jon.
Quast: Oh, sorry.
Hoium: So there's two things to think about with wash trading. One is, and we talked about this at the end of the last show, you can sell your cryptocurrency today and basically buy it back immediately, and recognize a loss which may be advantageous from a tax perspective, and that is legal for now. That loophole might be closed here in the near future.
The other thing that some people are doing with wash trading is using it to manipulate the market, and specifically with NFTs. Because if you go to something like OpenSea, you can see what all the transactions are in an NFT. If you want to make an NFT look more valuable than the underlying demand for it, you might use what's called wash trading by basically trading it from one wallet to another wallet, basically, selling it to yourself. That's where it gets a little bit hairier.
The interesting thing in an article that Jon shared was, most people are not actually profitable wash trading because, especially on Ethereum (ETH 2.83%), I mean, it's very costly to transfer things even from just one wallet to another. Unless you're really good at manipulating the market, it can actually be a way to lose money really quickly.
But it's just something to be aware of because this is like we talked about, this is a more unregulated market. There's not as many rules from a tax perspective or from a regulatory perspective as there are in other markets. Some of these short-term things like wash trading can be something to keep in mind.
In this case with Melania Trump's NFT, I think it was really more about saving face. It didn't sell at the price that they were hoping and it might look bad if it doesn't sell at all or doesn't sell at the desired price. We've seen that happen. We see that with art sales and things like that all the time. Not something that's that big a deal, but I think that's why it brought up wash trading.
Quast: Right. I guess the version of this that is a little bit more troublesome, a little bit more like this probably isn't sustainable, is not the saving face kind. Where, "This isn't working like we thought it was. Let's just go ahead and take it off the market through our own wallet."
The bad side of this is when you're trying to create this illusion that there's incredible demand for this NFT project. You're buying and selling it back and forth to yourself and the price is going up. Somebody unaware says, "Wow, this is hot. I got to get in on that." Then they finally put it up for sale and some dope buys it and they're left holding the bag while the person who was going back and forth makes a profit and runs, leaves them holding the bag, as they say.
This very clearly is happening in some cases. Most of the time they're not successful. But when they are successful, as the data from Chainalysis shows, it's wildly profitable. As long as it's profitable, it will attract people who are going to exploit that.
Hoium: This is what can happen in a very illiquid market. We talked about the Bored Apes. There are only 10,000 of those. [laughs] There's only maybe a 100 or 200 for sale at any given time. If you can manipulate the market in those and move it up 5 or 10%, there can be a lot of money exchanging hands there.
That's a really high-profile project. There are a lot of smaller projects that are probably more easily manipulated. So just be aware of that; if you see things going crazy, there may be something funky going on.
There are a number of people that I follow on Twitter that flagged these things when it happens. Sometimes there will be crazy sales that go on. There was some a crypto punk that sold for $20 million or something like that. This wasn't the alien that recently sold, but there was some really big sale and it was like they are actually just moving it from one wallet to another.
It was basically just taking the NFT from one pocket and money from the other and just switching them. [laughs] But they wanted to make it look like a big sale to bring attention to their NFT. That's something that happens as well, so just be aware of some of that funky stuff going on in the market.
