The Fast-Growing NFT Market Is Problematic Yet Promising

In some circumstances, is yield farming with non-fungible tokens (NFTs) another term for wash trading?

Yield farming is the process of getting tokens in return for providing crypto assets to fledgling marketplaces. The activity surged this summer starting with decentralized finance (DeFi) money markets like Compound. But now the game has migrated to other markets as well. Just like players at arcades, yield farmers put in money and get tokens in return. Then they use those tokens to play video games, hoping to win a prize by beating the game.

In the NFT space, this dynamic is being pioneered by Rarible, where users are rewarded with rari tokens for buying and selling digital collectibles. Rari token rewards propelled the site to quickly overtake other NFT marketplaces. However, this dynamic also created a fresh set of problems related to wash trading. Traders often swap these reward tokens for money on platforms like Uniswap. 

With more than 33,189 transactions tallying roughly $3.6 million in trading over the past month, according to NonFungible.com, there’s such a small market for crypto collectibles that wash trading can sometimes be difficult to identify. 

Michael Arnold, an engineer at crypto gaming startup My Crypto Heroes, said it’s important to distinguish between the different types of NFT wash trading. In short, wash trading traditionally means someone putting “buy” and “sell” orders at the same time, to create the illusion of demand. Sometimes people can wash trade while yield farming, but these aren’t usually the same thing. 

“Some developers have been spotted that did wash trading at the start. But I’d say it’s rare. Some users also did wash trading, which might be more common,” Arnold said. “But it really depends on the incentives. If you’re a whale in a game, you want to do wash trading to see your game high in the OpenSea ranks. If you’re trading on Rarible, you want to collect the governance tokens.”

Coinfund co-founder Jake Brukhman, an investor in Rarible, said the reason rari token rewards are closer to yield farming than traditional rewards programs is that rari gives users voting rights. 

“This is a story about a marketplace that came in with a bunch of incumbents and introduced a crypto-native monetization, through a token,” Brukhman said. “When you get rari you become a partial owner of the platform. This gives you a right to vote in the governance process.”

The governance token has functioned as a growth driver, long before voting options were viable, with Messari Research showing sales on Rarible surging to well over $6 million by Sept. 16. 

“Who these protocols are democratizing for is individuals and retail users. It’s easier for my brother to 10x his NFT investment on Rarible than it is for me as Coinfund,” Brukhman added.

Out of 25 million rari tokens created, roughly 30% are reserved for the Rarible’s team, while the plan is to distribute 60% to various user groups. 

“Some people are incentivized to create volume,” Rarible co-founder Alexander Salnikov said.

As the primary holders, Rarible wants to make sure the governance tokens retain value beyond yield farming, a daunting aspiration. Salnikov said he estimated more than 40% of the $750,000 worth of NFT trades on his platform in August involved some type of wash trading. Salnikov said the platform is adding transaction fees to help curtail this issue. 

Incentive models

Stimulating demand to collect reward points, like rari tokens, is just one form of NFT wash trading. Another form of performative trading could be compared to bombastic marketing, or chasing clout for visibility. 

For example, a whale can simply ask a friend to buy his collectible while a token accumulator requires many accounts and transactions. Some marketplace users are still just experimenting with “mutually beneficial” deals between friends.

Furthermore, platforms like Nifty Gateway that rank secondary marketplace sales might incentivize hops across platforms. There are also rare NFT galleries, like the Museum of Crypto Art which purchased the Picasso Bitcoin Bull NFT for $55,555 via Nifty Gateway, according to the artist Trevor Jones. 

For now, most of the value appears to come from the ability to transact with a geographically diverse community of crypto fans, including a few thousand artists and gamers. As with any crypto exchange, the platforms need to incentivize constructive user behavior rather than quick pump-and-dumps. 

It’s rare for authentic buyers to trade an asset many times within 24 hours, so this is one of the signs used to identify suspicious patterns. 

“We rely heavily on community signaling to identify those guys,” Rarible’s Salnikov said, adding they are denied token rewards. 

Governance challenges

From Brukhman’s perspective, if the platform can overcome these technical barriers to governance the profits could be extraordinary. 

“They have a bunch of challenges that are technical, but what’s most important for me as an investor is they’ve positioned themselves as a platform for all the different NFT types,” Brukhman said. “It’s also domain names, insurance, photography, 3D models, they’re going to become a Reddit for NFTs … that’s a much bigger market than art.”

Beyond liquidations on Uniswap, the rari token is primarily used to vote on governance options for the exchange. The Rarible platform does have an active community of digital artists, the Telegram group has 2,345 members and Discord has hundreds as well, where authentic trades and projects are discussed between fans. 

One such authentic fan, an artist who goes by Yeli, earns her primary income from selling artistic NFTs since her restaurant job shuttered in March. 

“The transition itself was pretty sharp, in the sense of going from a full-time job and making art every once in a while, to having all the time to create and brainstorm and collaborate with other artists,” Yeli said. “Luckily, though, I can say I’ve been blessed enough to have a small but steady stream of collectors lately who enjoy what I make enough to buy it and hopefully more people can take a look at it and feel the same way.” 

There are around 1,449 rari token holders, most of which weren’t blacklisted as part of identifying the problematic 40% of transactions. There does appear to be a consistent group of people who buy and sell NFTs. 

Plus, it’s unclear how accurate that wash trading estimate is. Some now-excluded Rarible users claim they weren’t involved with wash trading and the platform didn’t offer them any opportunity for explanation or recourse.  

“Some interesting projects related to NFTs were commissioned by a community member in the style of Japanese Waifus and community members were excited about it,” one such buyer who traded a flagged NFT, AaronTing8, said in a direct message. “Pretty much everyone I talk to who has bought the Yumiko NFT did not get the Rari airdrop. In fact, many did not receive Rari airdrops for other trading activities.”

The startup rectified this issue by issuing a special NFT, which jilted buyers could use to claim belated rewards from the previous Yumiko NFT purchases. Going forward, the startup aims to solve this issue with more direct community involvement, rather than routinely arbitrating themselves. 

“We have a plan to transition to a fully decentralized system,” Salnikov said in a phone interview, adding there will be a way for token holders to delegate their voting power to other parties. “There will be a DAO [decentralized autonomous organization] controlling all of this.”

At this stage, there’s no way to divorce speculation from future governance. Even artists like Yeli, who sell NFTs more often than she trades, find a curious appeal in the speculative aspects of the Rarible ecosystem. 

“The main attractive use of these cryptocurrencies lies in the ability to transact quickly and efficiently,” Yeli said, adding she uses bitcoin for savings and tokens for the operational needs of her NFT business. “But, also, I can’t say the speculative aspect isn’t a main draw. It’s fascinating to imagine earning a living in crypto, when the value can literally go anywhere.”

As for Arnold of My Crypto Heroes, he prefers to focus on collectibles that work as video game assets, not stores of value. This process is simpler because it usually doesn’t involve yield farming. At least, not yet. However, Arnold said, collectibles could someday become a part of the professional gaming industry. That might involve more complex token models. 

“You can compare it to cars: Unless it’s a very rare, old, valuable car, it’s meant to drive and will lose value over time,” Arnold said. “Once the infrastructure of lending and staking is in place, I can totally see NFT whales renting their NFTs to players for a revenue share on the rewards.”