NFTs have captured the public imagination with the endless digital design possibilities on offer and their multi-million dollar price tags. But they have also opened up ever more creative avenues for criminality: digital wallets in which NFTs are held can be hacked and the NFTs themselves can fraudulently attribute digital designs to multiple owners.
Keith Oliver, Head of International, at Peters & Peters Solicitors LLP, shares his thoughts on the current NFT craze.
“Fraud and deceit abound in these days more than in former times,” said Lord Coke in 1602, but what an apt expression for these uncertain days! Our ever-increasing reliance on digital tools for communication, banking, shopping or investing, has in turn prompted a rise in online hacking and phishing attacks. Cryptocurrencies have grown dramatically in appeal, despite these risks and their market volatility, and the art world is now the latest industry to try to exploit the distributed ledger to generate lucrative returns.
High stakes for high art
The potential for returns that outstrip traditional investments has long drawn armchair investors to cryptocurrencies, some of whom will no doubt have been reassured by market developments such as the UK Jurisdiction Taskforce’s Statement that cryptocurrencies are indeed property (a position now supported by case law).
However, many investors continue to show a significant lack of understanding as to precisely what a cryptocurrency is, so it’s no wonder that fraud in this area abounds. But just as investors start to come to grips with the subtle differences between DEX and Dogecoin, along comes a new alluring product in the form of Non-Fungible Tokens (NFTs).
Operating on the Ethereum blockchain, but not in themselves Ether, NFTs are a novel variety of digital assets. Unlike fungible tokens, such as Bitcoin or Ether which can be exchanged like-for-like and for other products of the same value, NFTs are inherently one-of-a-kind. They have no corporeal or product equivalent but are certificates to prove ownership of digital assets, in particular of digital works of art.
As digital design outpaces ‘physical’ artworks, NFTs may well become the transactional norm. Worryingly, a widespread lack of understanding of these products has not stopped us from paying exorbitant prices for them: the original meme ‘Charlie Bit My Finger’, for instance, recently sold for £500,000. Similarly, the recent $11.8m sale of a ‘CryptoPunk’ NFT at Sotheby’s, and frenzy of headlines it generated, suggest that the public remains captivated by the infinite opportunities on offer in ‘hyper-real’ markets.
Buy now, pay for it later
Unfortunately, any new investment opportunity opens up new opportunities for fraud. Just like Bitcoin and the other cryptocurrencies that followed in its wake, NFTs provide fertile ground for manipulation. Not only are the digital wallets that hold NFTs vulnerable to hacking, but both legal and illicit transactions involving NFTs are frustratingly difficult to trace. Because of this lack of transparency, it is relatively easy for NFTs to be sold to multiple buyers, each of whom would have paid a premium on the assumption of being the sole proprietor.
Once uploaded onto the internet, the digital design itself becomes easy prey for fraudsters, who can pass the image off as their own and sell it over and over if they wish. In theory, the technology underpinning NFTs should safeguard investors from this risk. In reality, however, ‘minting’ (attaching an NFT to) a digital piece that you do not own is fairly straightforward, as there is no requirement to demonstrate ownership of the copyright – in some cases providing social media handles is the only verification required. With checks and balances that are so wholly inadequate, it is not surprising that fraudsters are flocking to NFT selling platforms.
The road ahead
The idea behind NFTs is sound in principle: to offer robust authentication of a digital transaction. Unfortunately, the technology appears to have created a wild west where fraudsters can operate with impunity.
But there are things that can be done. The first step is education, to ensure that more investors avoid being dazzled by the technology but instead maintain a keen eye on the fundamental concepts of risk and return.
The next step is to re-boot the regulatory framework and so that legal powers to trace misappropriated funds or works can be engaged more rapidly. The good news is that many of the necessary tools already exist, such as proprietary injunctions, disclosure orders and worldwide freezing orders, and are increasingly being used to track cryptocurrency assets that have been lost to fraud. We need to learn from the swathes of frauds that followed the launch of Bitcoin over a decade ago and act swiftly to deploy this same arsenal in the context of NFTs.
Where money goes, fraud will invariably follow. Investors are queuing up to get their hands on NFTs. Regulators need to get to the front of the line now if they are going to stand any chance of protecting them from fraud.