Impact of Wash Trading in the NFT Market

The Non-Fungible Token (NFT) market in the Ethereum blockchain has gotten a lot of attention in the past years, due to its explosive growth in 2021 and its quick decline. This creates an interesting case study for examining speculative bubbles in emerging markets and the psychological factors driving them. The platform has been lucrative for many emerging digital artists due to its decentralization aspects. However, this has left room for extensive malicious behavior from users, such as wash trading, which has become prevalent in the NFT market. Wash trading is a form of market manipulation that artificially inflates an asset's volume or price. It often involves an individual or group transferring assets without taking on any financial risk to give the illusion that the asset is in high demand, which often leads to an unusually high trading frequency. As a result, to detect wash trading I will be looking at transaction data to determine outliers within the art series that have higher-than-average trading frequencies. Different NFT series have varying holding periods, so breaking down the categories will give a more accurate depiction of whether wash trading is occurring. Wash trading leads to an unsustainable level of price inflation in a market. This is due to investors following perceived market trends without properly assessing the value, contributing to bubble formation. To detect nonstationary behavior, which makes an asset prone to bubbles I will perform an Augmented Dickey-Fuller (ADF) test on the asset prices of NFTs. This will detect if the asset price is growing exponentially while taking into account lags, which will show if a bubble is occurring. I will then be able to compare the results in order to determine if high amounts of wash trading correspond with high levels of bubble activity. I will get the transaction and asset pricing data from XBlock or NonFungible.com, both of these sites collect current mainstream blockchain data. The paper suggests how certain regulations and policies can create a more secure market that discourages wash trading. Understanding this complex, emerging digital market can inform new policies to help reduce future market inefficiencies and prevent financial losses.