NFTs have surged in popularity over the past year, with many people flocking to invest in what is marketed as a valuable and unique digital asset.

However, the value of these assets can be inflated by wash trading - the practice of trading the token between accounts owned by the seller to give a misleading view of its value and liquidity.

What is a non-fungible token - and why are some digital artworks selling for millions?

What are NFTs?

NFTs are a token of ownership attached to a blockchain. Their proponents claim they are a unique asset class while critics say the token is fundamentally valueless.

Despite the debate, more than $44bn (£32bn) worth of cryptocurrency was sent to NFT-related smart contracts last year, up from just $106m (£78m) in 2020, according to a new report published by Chainalysis.

Chainalysis, which offers a blockchain data platform for law enforcement and other organisations, has published a study identifying the scale of wash trading to artificially increase the value of NFTs.

Wash trading is a market manipulation tactic that gives the impression that a financial instrument is in more demand than it actually is by trading it for higher and higher prices between accounts operated by the same actor.

How big an issue is it?

Using blockchain analysis, the investigators have been able to identify hundreds of addresses that initially send funds to a buying address before then exchanging a token with that address for the funds it had originally sent.

However each of these transactions comes with a cost, and for many wash traders the cost has been greater than the ultimate revenue they brought in from trading the NFT to a victim who has overvalued the token.

Of 262 traders whose history was investigated by Chainalysis, 152 had ultimately made a collective loss from the practice of more than $416,000 (£306,000) - but the collective profits made by successful traders revealed that practice was immensely profitable overall.

Of the 110 traders who didn't lose money, the collective profit was greater than $8.8m (£6.5m) with those funds being "most likely derives from sales to unsuspecting buyers".

These victims "believe the NFT they are purchasing has been growing in value, sold from one distinct collector to another" when in fact they have just been traded between accounts controlled by the fraudster.

Chainalysis said it was likely there was wash trading that the company had not identified.

Although the practice is illegal in the US when it comes to conventional financial instruments, there has not yet been an enforcement action regarding NFTs which are a largely unregulated asset class.