Wash trading occurs when a trader or investor buys and sells the same securities multiple times in a short period to deceive other market participants about an asset’s price or liquidity.
As mentioned, wash trading involves an act in which the same asset is sold and purchased within a short time. To influence an asset’s trading activity and price, traders use wash trading as a market manipulation technique. Typically, one or more colluding agents undertake a series of trades without considering market risks, resulting in no change in the antagonistic agents’ original position.
In October 2021, Cryptopunks, a Larva Labs NFT project, witnessed something like a “wash sale” on the Ethereum blockchain. The cryptocurrency “CryptoPunk 9998” was sold for 124,457 Ether (ETH). The ETH used to purchase the NFT was transferred to the seller, then returned to the buyer to repay the loan used to buy the digital blockchain art from Larva Labs — effectively making it not only a flash loan but an example of significant NFT money laundering.
A trader or firm may be motivated to engage in wash trading for various reasons. For example, the purpose could be to stimulate purchasing to raise prices or encourage selling to drop prices. A trader may conduct a wash sale to lock in a capital loss before repurchasing the asset at a reduced cost basis, basically seeking a tax refund.