NFTs or non-fungible tokens, commonly built on the ERC-721 standard atop the Ethereum blockchain have been soaring in popularity.
Earlier this year, payments giant Visa purchased CryptoPunk 7610 (the one with the red lipstick) for around 49.5 ether, or around US$200,000 at the time.
So when another CryptoPunk 9998 was alleged to have sold for half a billion U.S. dollars’ worth of ether, naturally there were many who believed that the NFT bubble was still well and truly alive.
Except that it wasn’t.
A closer inspection showed that the ether from the NFT trade ended up right back where it started – a process known in the financial world as “wash trading.”
Allegedly, the process started when someone using an Ethereum address starting with 0xef76 transferred CryptoPunk 9998 to an address starting with 0x8e39 and around thirty minutes later, 0x8e39 sold the NFT to an address starting with 0x9b5a for 124,457 ether, worth around US$532 million at the time, all of which was borrowed from three sources, primarily Compound, a decentralized lending platform.
To pay for the trade, the buyer, 0x9b5a, sent 124,457 ether to CryptoPunk 9998’s smart contract, which transferred the ether back to the seller 0x8e39, who then sent the ether back to the buyer 0x9b5a, who repaid the loans.
Finally, the complete the apparently meaningless round trip, CryptoPunk 9998 was sent back to the original address 0xef76, who then proceeded to offer the NFT up for sale again, except this time the price had increased to 250,000 ether.
The entire process is possible because of so-called “flash loans” which are enabled by the Ethereum blockchain, where a loan can be taken, used to pay for something and repaid all within the same block, meaning that no interest is paid, and no collateral is necessary.
But this is hardly the first time that such large bids have been used to goose up NFT bids and lure in the unsuspecting.
Because the ether is offered and rejected in a single transaction, the bid is briefly valid even though it can never be accepted and for those who are unfamiliar with the NFT ecosystem, may be misinterpreted as a genuine offer for an NFT.
Larva Labs, which created the CryptoPunks said on Twitter that they would ensure their notification system would filter out such transactions in future and prevent them from being notified.
Yet while large bids like the one for CryptoPunk 9998 would immediately attract attention and greater scrutiny, far smaller bids may go unnoticed and lure in unsuspecting NFT buyers into paying more for an NFT than they would have otherwise.
In the market for regulated securities, a transaction like the one for CryptoPunk 9998 would be the equivalent of wash trading, which is banned on the grounds that trading with yourself can artificially inflate prices and suggest there is more demand than actually exists.
And because in the crypto markets, the only thing expended is gas (transaction) fees, there is a strong economic incentive for holders of NFTs to engage in this sort of wash trading to artificially create the impression of an active market for a token when none otherwise exists.