Non-Fungible Tokens (NFTs) have taken the world by storm, leading to widespread interest and increased adoption of cryptocurrencies. According to blockchain analytics firm Chainalysis, the popularity of NFTs skyrocketed in 2021. Chainalysis’s “NFT Market Report” shows a minimum of $44.2 billion worth of crypto sent to Ethereum smart contracts associated with marketplaces and collections of NFT last year. The report notes that this number was $106 million in 2020.

While impressive, more and more scams and fraudulent activities have infiltrated the NFT space. For example, major NFT marketplace OpenSea recently announced that its free minting tool was prone to misuse. As a result, OpenSea shared that 80% of NFTs created using this tool were plagiarized, fake, or spam. If that wasn’t bad enough, Chainalysis’s latest blog post highlighting its “2022 Crypto Crime Report” found that the NFT sector is vulnerable to laundering trade and money laundering.

Laundering trade grows in the NFT sector

According to the blog post, wash trading refers to a transaction where a seller is on both sides of the trade to paint a misleading picture of an asset’s value and liquidity.

Unsurprisingly, wash trading has become a major concern within the NFT sector. More recently, data generated by the LooksRare NFT marketplace found that the platform was highly prone to laundering trades.

However, as wash trading becomes more common in NFT markets, new solutions are being developed to detect fraudulent activity. Kim Grauer, head of research at Chainalysis, told Cointelegraph that the company has created a potential tool capable of detecting people who self-fund their own crypto wallets for deceptive transactions:

“Using Chainalysis software, we can see when a person buys a token with funds from the same person who sold them that same token. This is the definition of wash trading.”

The Chainalysis blog post further explains that by using blockchain analytics, the firm is able to track NFT laundering trading by analyzing NFT sales to addresses that were self-funded, meaning they were funded by the selling address or by the direction that financed initially. the sales address.

Interestingly, while Chainalysis found that some NFT sellers have done hundreds of wash trades, Grauer noted that most NFT wash traders are not profitable. She said:

“In general, we find that it is not profitable to launder commercial NFTs because you end up paying a lot in gas fees. Many car wash dealers came out negative due to the amount spent on gasoline versus the amount generated from their sales.”

More specifically, Chainalysis findings indicate that 152 Ethereum addresses associated with wash traders resulted in losses of $416,984. On the other hand, Grauer noted that some wash merchants have been successful. Chainalysis data shows that 110 Ethereum addresses received $8.9 million in profit from wash trading.

According to Grauer, successful wash traders tend to be people who do multiple NFT trades on various platforms. However, he noted that it is generally not a good idea to launder trade due to the high costs of gas fees, coupled with the fact that all transactions can be seen on the Ethereum blockchain network. “This is a risky type of crime to commit, and even more risky given that people have to pay large gas fees. Those who do this on a large scale must have experience,” Grauer said.

How NFT platforms can keep users safe

While laundering commercial NFTs have been shown to be risky and unprofitable for most, Grauer believes this activity will become more common as the NFT space continues to grow. “Anyone can easily participate in wash trading – if you can download an ETH wallet and buy an NFT, you can,” he commented. With this in mind, it is becoming increasingly important for NFT platforms to implement initiatives to help keep users safe from fraudulent activity.

Alex Salnikov, co-founder and head of product for NFT marketplace Rarible, told Cointelegraph that in terms of what the platform has seen in the broader NFT ecosystem, there tends to be a pattern of user laundering on platforms that provide incentive rewards for trade. . At Salnikov’s point, the LooksRare platform planned to offer rewards to users in the form of the platform’s native token, which could have increased the number of laundering operations on the platform.

Salnikov explained that after becoming aware of this vulnerability, the Rarible Decentralized Autonomous Organization voted to stop the distribution of RARI tokens to Rarible users. As a result, “the issue is no longer relevant to our market,” he said, adding that to further protect Rarible users, the platform has launched a verification system that allows the Rarible team to manually review a user’s profile. creator. Salnikov elaborated:

“If this process is successful, the user will get a yellow check mark on their Rarible marketplace profile. It’s important to note that collectibles from unverified creators do not appear in our search results or explore feed. Users are also warned if they are about to purchase a collectible from an unverified creator or collection.”

While Rarible has taken a number of steps to ensure user security across the platform, Grauer mentioned that Dapper Labs, a blockchain platform that offers NFT-based products and decentralized applications, is working closely with Chainalysis to monitor wash trading and other illicit activities.

Additionally, OpenSea published a blog post on January 17 introducing its new “NFT Security Group”. According to the post, members are expected to share and learn about vulnerability reports that have not been publicly announced in order to fix issues before users are affected. Members will also focus on building solutions to ensure greater security around blockchain consensus, smart contacts, wallets, and metadata, along with awareness of interoperability implications.

Will regulations keep users safe?

In addition to these measures, the discussions on CLS and compliance are bearing fruit. Joseph Weinberg, co-founder of the Shyft Network, a compliance-focused blockchain network, told Cointelegraph that while it’s hard to say whether NFTs should be regulated, he thinks the space needs oversight:

“I think commercial platforms that accept funds, like OpenSea for example, will inevitably be regulated as VASPs, as they are in the business of matching counterparties and accept fees. As far as how NFTs can be regulated, you can do things like multi-address hop detection and address detection to group and determine if there’s a chance people are operating laundered.”

However, Weinberg commented that NFTs remain a gray area when it comes to regulation. “The regulators have not even been able to give us clear guidance on DeFi [decentralized finance]so I think they are waiting to see how it plays out,” he said, adding that the biggest challenge regulators are currently facing is the fact that art is not a regulated environment:

“Historically, art markets are known not to be subject to KYC [Know Your Customer] and AML [Anti-Money Laundering] requirements It is also widely known that the art world is where a great deal of money laundering takes place, and has been for a long time. The question to ask is whether ‘form’ is different from ‘function’ because a token has a different set of use cases than a piece of paper.”

As such, Weinberg believes that regulators should first focus on how NFTs should be addressed before offering guidance. Meanwhile, some industry insiders believe the NFT community will take its own set of actions. Jack O’Holleran, COO of Skale Labs, a platform that develops solutions for Ethereum scalability, told Cointelegraph that he thinks free markets will ultimately prevail. “End users will not want to purchase NFTs from sites that do not clearly remove or call out commercial wash numbers. NFT traders and buyers will move their businesses to data aggregation and exchange sites that give them real views of market data.”

NFT scams will continue to rise, even with solutions

Unfortunately, even with compliance solutions, NFT platform initiatives, and potential regulations, Grauer predicts that there will be a spike in criminal activity in the NFT space before there is a decline.

Furthermore, while Chainalysis found that money laundering associated with NFT addresses was relatively low in 2021, Grauer expressed concern that the space will only continue to get worse. “My prediction is that the sector will get worse in many ways before it gets better with industry solutions. Some NFT platforms may adopt compliance to help move things forward.”

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