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18.02.22

NFTs and fraud: What to look out for and what you can do if you are scammed

Non-Fungible Tokens (NFTs) are the new hot topic in the crypto space, with global NFT sales passing the $4billion mark at the beginning of 2022. Of course, with so much money at stake in an industry that has little to no regulation by design, it was only a matter of time before fraudsters began taking advantage of the situation to attempt to enrich themselves at the expense of others.

What are NFTs?

Non-Fungible Tokens are bits of information, stored on a blockchain, that are not interchangeable with each other. This distinguishes NFTs from both crypto- and regular currencies, such as Bitcoin, Ethereum, or pound sterling. Typically, any one coin of a currency can be exchanged for any other coin of that same currency with the same face value (any £1 coin, for example, is interchangeable with any other £1 coin and any 1 BTC is interchangeable with any other 1 BTC). NFTs are not interchangeable in this way, which is why they are referred to as “non-fungible”.

NFTs are created (“minted”) by associating information with the existing crypto infrastructure (the most popular of which is currently related to the Ethereum blockchain and its associated cryptocurrency, Ether) and are stored in unique digital wallets (“addresses”) secured by security keys (long, computer-generated passwords). The decentralised blockchain associated with the crypto asset used to mint the NFT acts as an open, publicly-readable, ledger of which tokens are owned by addresses. The information associated with the token is usually some kind of digital media.

What does it mean to own an NFT?

When someone refers to owning an NFT, what they typically mean is that they have access to some kind of digital media (usually a picture or a video, but it can be almost anything, including the chemical wavelengths of a ‘digital perfume’ or even the source code for Tim Berners-Lee’s original world wide web) and they have the token associated with access to that piece of digital media which provides proof of their unique ownership.

This does not mean that there is a one-to-one relation between tokens and media items, however. People can mint multiple NFTs of a particular item and serialise them (like trading cards) or could split a media item into multiple pieces and make a token for each part (like making an individual NFT for every distinct page of a book).

Owning an NFT, however, does not necessarily mean that you legally own the media associated with the token – as some over-enthusiastic, but ultimately misguided, Dune fans found out recently. The situation is analogous to buying a physical collectible item, like a painting – simply owning a painting does not necessarily grant you the right to display it in public, nor does it necessarily give you the right to sue someone for reproducing that painting without your permission (or indeed to reproduce it yourself). Likewise, purchasing an NFT does not necessarily grant you any rights besides simple ownership of the associated token.

Having said that, the situation can change based on any agreements contained within the NFT itself and can rapidly get quite complex, especially for a casual user that wishes to explore the NFT-space. For example, the band Kings of Leon recently turned their latest album ‘When You See Yourself’ into a series of NFTs, generating revenue of approximately $2million in the process. The licence agreement that underpinned the NFTs is, as you can see here, extensive, legally dense, and has implications that may not be immediately obvious to fans simply looking to buy a collectible part of band history, such as potentially allowing your data to be used for advertising purposes.

99 Problems and NFTs are most of them

Even seemingly successful projects can turn into bitter disputes when royalty agreements are entered into without full understanding from both parties as to what that means both legally and in the crypto space. This is one of the live issues (amongst many) in Jay-Z’s and Roc-A-Fella’s dispute with Damon Dash about the latter attempting to auction Reasonable Doubt off as an NFT. In reality, copyright protection can and will eventually expire. However, smart contracts that bestow royalties, such as those that are regularly entered into as part of minting an NFT, once committed to the blockchain, are perpetual and operate automatically, with legally complicated consequences that can be both civil and criminal.

Avenues of attack

To heap further confusion and risk on top of what can already be a relatively complicated area, unscrupulous individuals and organisations have seen the huge sums of money involved in NFT projects and are actively employed in attempting to defraud others in the space. Some of these fraudsters’ avenues of attack are held in common with cryptoassets generally, while other routes are uniquely related to the features of NFTs themselves.

“Good artists borrow, great artists steal”?

NFT projects, as mentioned above, can involve collaborations between digital media artists and crypto-backers to mint unique digital artworks and collectibles – as is the case with the Bored Ape Yacht Club, whose collection of unimpressed simians will be familiar to anyone brave enough to have ventured on to Twitter.

Unfortunately, based on the success of projects such as these, scammers have started scouring the internet for original artworks that they think would be attractive, taking them, and minting them into NFTs without their creators’ permissions. Alternatively, artists have been brought into projects, with the promise of payment, only to have payment refused and their work taken and minted into NFTs regardless. This unauthorised usage of original artworks is rampant and ubiquitous (with leading NFT website OpenSea recently revealing that on their platform over “80% of the [NFTs] created… were plagiarised works, fake collections, and spam”) and, pace to Picasso, causes real harm to artists.

Free lunch frenzy

Other scams are more technically insidious. A relatively common scam is for fraudsters to send free NFTs to an individual’s wallet, with the suggestion that they may be worth something. However, the only way to realise the value of these free NFTs is to join the fraudster’s trading platform, whereupon malicious code within the freebies automatically executes and drains the individual’s wallet entirely. Unfortunately, once the drain starts, there is usually no way to stop or reverse the transaction.

Alternatively, a fraudster may come forward, impersonating a project leader, and suggest that they have decided to mint more of a previously limited edition NFT – providing a link that will request cryptoassets or private wallet keys to proceed. This flavour of scam is particularly common on Discord and Telegram, where fraudsters can code bots to contact thousands of potential victims a day, but can occur anywhere with a messaging system.

How are NFTs like ladies’ shoes?

NFTs, as with other crypto assets, are also used as vehicles for the same kind of “pump and dump” scams that lead to the downfall of Steve Madden and Jordan Belfort of Wolf of Wall Street fame. In this case, step one involves creating an NFT collection. Step two is creating a series of wallets and addresses all controlled by the fraudsters. Step three is selling the NFTs back and forth between fraudster addresses, increasing the price each time, artificially driving up the NFT's apparent value while no money actually leaves the fraudsters’ hands. The final step is finding someone to whom to sell the inflated NFTs – to add insult to injury, this can be achieved via a fake auction where there is only one “real” buyer, driving the price up even further. The poor buyer is left holding NFTs, for which they paid an exorbitant price, that they will find very difficult to convince non-scammers as being worth anything at all. The fraudster, on the other hand, is then free to start again at step one with a fresh collection.

What can I do to avoid getting scammed?

Given the sophistication of fraudsters and the scams that they are attempting to pull, as well as the speculative value of NFTs themselves, we would generally advise exercising extreme caution before entering the NFT space – fraudsters cannot steal your NFTs if you never own any in the first place.

Short of complete abstention, our top four tips to avoid getting scammed in the NFT space are:

  1. Do your research – if a project has appeared over a short time, has a development team that has not identified itself with real-world names, or if it claims to be a limited-time event, then it may be fraudulent.
  2. Keep your private key private – never enter the private key to your wallet into any website that is not officially verified. Double and triple check any URL links for misspellings, or other irregularities. Always use two-factor authentication.
  3. Don’t believe the freebies – if you find yourself receiving free NFTs, stop and think about why that might be. Your wallet is like your email inbox, anyone can send you anything at any time if they know your address. If the product is free, then you are the product!
  4. Stay on guard – in an unregulated space like NFTs, or the broader crypto-space, it pays to be paranoid. Always be questioning motivations, whether it’s the trader that apparently wants to make you both money or the artist that needs your Ether to mint a masterpiece.

What can I do if I have been scammed – can I take legal action?

There are several different routes that can be taken to try to remedy the harm perpetuated by a fraudster, up to and including legal action. The exact methods will differ depending on the nature of the scam itself and whether the goal of the action is to recover the NFTs themselves, the cryptocurrency used to pay for those NFTs, or obtain some kind of recompense for work done or intellectual property infringement. Causes of action can include:

Breach of contract

If you are an artist who has found payment has not been forthcoming in relation to an NFT project to which have contributed, or there is a dispute over the implications of a royalty agreement, you may have a claim in breach of contract. An important note is that there does not have to be a formal written contract for there to be a breach, however claims with significant written material are substantially easier to pursue.

Copyright infringement

There are a variety of ways this could happen.  If you are the artist, and your copyright has been infringed by a scammer minting NFTs of your art, it is (legally speaking) a straightforward copyright infringement matter.  Identifying the culprit and making any kind of recovery is likely to be the biggest issue.  If you have purchased an NFT only to find out the seller did not have a license from the copyright holder, your remedy is in breach of contract (above).  In both cases, the scammer may have also committed a criminal offence contrary to section 107 of the Copyright Designs and Patents Act 1988.

Misrepresentation and the tort of deceit

If you have been the victim of someone claiming to be someone they are not (e.g. an NFT project lead, trader, or website representative) and you have suffered a loss because of your reliance upon their claims, then you may have a misrepresentation claim or a claim under the tort of deceit.

Litigation in relation to fraud generally, but cryptofraud especially, is expensive, however there are certain steps that are useful in all of the above three circumstances. The first step is often to identify the fraudsters/other parties involved, including potentially obtaining information about them from third parties via a Norwich Pharmacal order. It is also important to investigate what, if any, assets they have, given the special challenges that enforcing judgments against crypto assets (including NFTs) can entail. If justified, freezing orders can be sought and enforced.

Of course, the perpetrators may well be based outside the jurisdiction.  This can cause both legal and practical complications, such as obtaining permission to serve proceedings abroad, affecting service and tracing and enforcing against foreign assets.  Whilst these issues are often surmountable they can significantly increase the cost and length of any litigation.

NFT and crypto fraudsters are used to thinking that they are untouchable, but this is increasingly not the case. As demonstrated by the recent seizure of three NFTs by HMRC in relation to a fraud worth £1.4m and of the seizure of $3.6b worth of Bitcoin by the U.S. Justice Department, there are real and tangible consequences to committing fraud in the crypto space.

Having said that, the law surrounding NFTs, cryptoassets, and blockchains, much like the technologies themselves, is complex and ever-developing. We would strongly recommend taking specialist legal advice if you feel that you have been the victim of an NFT or crypto-related scam.

 

Click here to find out more about how Brett Wilson LLP's specialist fraud lawyers can assist you if you have been the victim of a NFT fraud.


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Legal Disclaimer

Articles are intended as an introduction to the topic and do not constitute legal advice.


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