The Economics of Wash Trading in the NFT Markets

Transcript

foreign [Music] hello everyone uh thank you all for being here today today I'm here to talk about the economics of watch trading uh my name is Leo and um so essentially like who am I first um I'm Leo my ideal name is Edward and essentially I'm the founder of supersite and what we're doing is we're building like crypto specific large language models and essentially what we try to do is like we try to make sense of the information in the sea of noise so we're trying to build large language models

that are specialized to both on-chain and off-chain information and additionally like what I do is I'm a PhD candidate at London Business School and my research specialization is in crypto wash trading and previously I was the head of research at fabric Ventures lecturer of portfolio management at UCL and I was also a lecturer of machine learning at O'Reilly and let me tell you a bit more about the meat of the presentation today so we're going to be talking about watch trading and I'm going to start out by explaining the concept of wash trading for those who are not familiar in the room this despite it already actually being a very popular concept but essentially like

what was trading fundamentally is is when like two pietys actually exchange Assets in between them uh without the risk actually ever like being transmitted to either python like that is the um like proper financial definition of worth trading and how we observe it on chain is that essentially like uh if you look at this loot like this loot was actually worst shaded between two parties let's say John and Lisa um so this loot was sold for 472 ethereum from John to Lisa and then back to John so essentially we can see that like there was a lot of volume in these trades but like there was actually no

exchange of um firstly like money and assets so like this is a concept that I found very interesting that is prevalent in the nft markets and um so essentially like I was really intrigued by this problem and I wanted to see how big of a problem is it so essentially like I looked at like the nft transactions that uh for collections that have greater than 100 ethereum in volume and what I find is that 73 of my sample is actually wash traded and uh which is like super surprising and then uh if we like dig into it deeper then essentially what I found was that before 2022 like the amount of worst trading that was happening in the nft markets

was more or less very healthy um but then like from 22 or 2022 onwards like it just exponentially grew like we can actually see that the amount of wash trading in the nft markets uh was more than like the amount of real trading in the nft markets for most of 2022 and um so like how do I actually detect wash trades so in order to actually detect wash trades what I do is I employ a graph based cycle detection methodology so we know that like um wash trading can happen between like two wallets but like it can also be happening uh all the way up to like 50 100 wallets it doesn't matter whether that n is and uh so like I basically try to look for whenever

like a cycle is completed in a transaction graph and uh what I flag is that each of the wallets in those transactions is actually a worse Trader and I was really curious about why does it actually happen like why do people wash trade so much in the nft markets why did it actually start in 2022 and um so uh firstly like let me tell you a bit more about wash sharing in the financial markets so uh in the financial markets it's actually illegal to be worth trading um so essentially like what happens is a lot of people will like used to try to sell their stocks in December and then buy the same stocks back in January and essentially what they were doing was

like writing like the tax writing the stock as a tax write-off and what they were doing was tax loss harvesting and then I tried to find instances of this in the nft markets and I found some so if you actually like pay attention to what happens in December and January you'll find that like in December like the price of nfts slumps a little because there are if you look at the average prices and then in January like it starts picking up like for no reason in the first few weeks and what's happening is that like a lot of people are buying the same asset that they sold um so it looks like there's a lot of things happening and um so this was my first hypothesis but then like I

realized that this cannot explain the entire phenomena then I thought that maybe it's that like you know wash sellers probably want to pump up the volumes of their collection to make it look more attractive to investors like do they actually just want to make sure that their assets get sold at a higher value and this was motivated by the fact that when I looked at like what was happening to the average prices of nft sales so essentially like in January we can see like the average prices of worst sales touched 500 000 in a week and I thought maybe this is what's happening but then um I dug deeper into where is it happening and then I realized that like

before 2020 to like the amount of wash trading that was happening was all on Open Sea which was a small amount as we saw and then from 2022 January like it was on looks red uh from like may it was an X to Y2 and like October onwards it was on blur and essentially what all three did was like they launched token rewards programs um so you were actually motivated by a financial incentive by marketplaces to worst trade and I looked deeper into like what is happening at the collection level um so like these two plots actually showcase like what's happening in two popular collections the first on the

left is board API Club the second on the right is terraforms terraforms is mostly wash rated like I was completely shocked by the amount of wash shading that I found in terraforms according to my analysis it was 12.2 billion dollars of worst trading and then um so um essentially I looked at like board apiat club and what I found was that like the um like my index uh for wash trading actually grows like around the rewards programs launches for luxray and x2i2 and if we actually dig deeper then there was a very clear incentive for Traders to actually be wash trading so essentially like you can see like the

green um like area that is marked between these two lines so that is the difference between the token price and the break-even price and um so essentially like this was the incentive that like um wash Traders had for watch Trading and um essentially like in my research what I did was like I did I did like over 100 regressions to actually uh for figure out the relationships between like all of uh these metrics like what is happening on the volume level what is happening on the uh price level what is happening to the number of transactions what is happening to the market and essentially what I find is that like uh in the overall market like uh wash trading is actually like

um essentially it drowns out and there is no significant relationship between volumes or prices um of like real sorry wash volumes with real volumes in the following days but like if we go deeper into like what is happening like on an exchange level what I found was that wash volumes today actually uh positively impact real volumes tomorrow but they negatively impact uh real volumes all the way forward so essentially like uh what I found was that like my index my indices showed the same results my prices show the same results so essentially what I found is that wash shading in the short term is good for the market but in the

long term is actually negative for the market because it discourages people from buying the um like assets that are heavily was traded and then I was really curious about like are people actually making money from worth sharing and um so like on the right like uh I know it's a bit small but essentially what I found was the p l for all of these wallets that do do wash trading um was more or less negative um so I wasn't very sure like whether they're actually making money or not and Machi is very popular in the community for this um I don't know if he's gonna get the rewards in proportion to his efforts but I I did not really find much

evidence it's a very profitable activity but it may be because like watch Traders have multiple wallets so essentially like these wallets might be in loss While others are in profit but uh yeah I mean like if you actually want to find the same insights that I found like after digging in um like for hours on end through like different analytics platforms and essentially uh you can use supersite um and what we're building is um like our system for you to be able to um like ask these questions in natural language so that um like you don't have to write any lines of code but uh so that was me that was that's supersite and that's wash trading in the nft markets

[Applause] questionable hi Leo thank you for this talk really interesting and great data um I had a question about whether or not you looked at different communities so if you found so you compared a boarding yacht club with terraforms and if you found any partic any other types of patterns and the types of trading activities so um you know for example risk taking or um maybe holding activity or other types of patterns that's great question um so I did do a bit of a deeper dive

into like each of the uh top nft collections to find like uh first thing like how loyal are their communities um so like what is the retention statistics like for each of these communities and then um so I found out that um I mean before all of this happened like azuki was one of the most loyal communities I haven't checked since uh like the events took place but um yeah you're right there's actually a lot that we can get um like from from looking at blockchain data and if you want to ask any of these kinds of questions then you're welcome to use use supersite because you can directly ask questions like retention statistics for azuki or you if you want to compare it to other nft collections

so you can do that well I'm not too far away from you I'm at Cass business school so I'll definitely follow up deal uh looking outside the context of nfts have you analyzed platforms like dydx in the context of uh watch trading specifically when you're looking at long-term liquidity and uh because I would argue that maybe their incentives have kept uh long-term liquidity on the platform over the past few years that's a great question I haven't actually looked at the fungible token

markets yet but I see where you're coming from like uh essentially like Traders do have an incentive to like wash trade on spot so that they can manipulate the price of perpetuals as well um I think that there are actually a lot of incentives for wash shading like as you mentioned um plus like just like being able to exploit these instruments uh but yeah I think that would make for interesting research that I've not done yet but uh hopefully I can look into it soon thanks hey uh thanks a lot for your representation super super insightful maybe just one question back on the I think very first chart that you showed which was like the proportion of wash

trading across platforms uh over time I think that was the one with the red and green uh I was uh that's right I was the the one before actually um showing non-wash versus wash and I was surprised to see there was like basically zero or almost zero um wash uh before January 2022 and then it just spiked like crazy um which which is like seems odd so I don't know if you had some yeah insights or potential explanations for this like sudden move uh from January that's a great question like uh to be honest like before the launcher of uh luxray which happened in January 2022 um like all of the war shading was

happening in openc and uh like there there is a small amount there which is actually less than two percent um and uh I mean what I found was um like essentially a lot of that was happening in like the crypto punks collection and a few like other collections like three or four but uh it was not that prevalent of an activity because it was just not as incentivized and then like in January luxray launches with its Rewards program and then like the proportion just goes out of control yeah anyone else awesome

okay thank you thank you everyone [Applause] [Music] foreign [Music]