The notoriety and value of non-fungible tokens has increased exponentially this year, leading many people to invest amid a fear of missing out.
The similarities with cryptocurrencies do not end there: many projects ultimately falter, leaving investors out of pocket.
While this is to be expected in a nascent market – not to mention startups in general – there are many instances where the motives of the founders behind NFT projects can be called into question.
Just this week, for example, OnlyFans model and former Love Island star Vanessa Sierra closed her SmolBoyzLand NFT project amid claims of a ‘rug pull’.
Launched in March, it raised 127 ETH (worth up to $400,000 at the time) in mint funds which the founders subsequently transferred to their own wallets.
The collection of 9,999 NFTs with tennis-based characters – said to be inspired by Sierra’s Australian tennis player ex-boyfriend Bernard Tomic – was described as a “metaverse DAO focused on strategically acquiring blue-chip NFTS” planning “to buy up all of the land in the metaverse”.
For her part, Sierra says people should learn to differentiate between ‘rug pulls’ and failed projects. Looking wider, there are many more NFT schemes where even the identity of the founders is difficult to ascertain.
“Due to the inherent anonymity of the internet and Web3, many of the teams behind new projects are anonymous,” Clyde & Co experts Stuart Evans (partner), Priya Sejpal (associate) and Arthur Caplin (solicitor) tell BusinessCloud. “Here lies the problem.
“There have been many instances where anonymous teams have received significant funds following a successful NFT launch, then taken the money and run, leaving the project under-developed, unmanned and often worthless.”
These types of occurrences are dubbed ‘rug-pulls’ or ‘rugging’ by the NFT community. The community and investors in these circumstances often find themselves chasing shadows, unable to pursue recourse.
Like any other business, failure to obtain necessary legal advice and undertake due diligence could easily expose a business to unnecessary risk, which could result in not only the failure of the project but also in personal liability.
What is an NFT?
Non-fungible tokens are unique assets whose value cannot be replicated, such as famous works of art. NFTs are also used to prove ownership of an asset and are indivisible, creating digital scarcity.
Each NFT on the blockchain – a record of transactions – has an owner, with an account associated with the ownership. NFT transactions are recorded on the blockchain, and ownership is updated via a decentralised immutable ledger where no data can be altered.
“As such, it is almost impossible to create counterfeits,” say the experts.
A large percentage of NFT project funds are generated following a public ‘mint’, the process of turning a digital file into a crypto collectible or digital asset, stored on the blockchain.
“As the teams behind these projects are often unknown and crypto scammers are notoriously hard to trace, there isn’t much preventing them from transferring the funds from the project’s crypto wallet to a separate account, enabling the fraudulent team to easily disappear with the funds,” they add.
Legal recourse
So is there anything disaffected investors can do to fight back?
The first consideration for investors is whether the ruggers can be brought to justice. This requires consideration of whether a criminal offence has been committed, and if so where.
The threat of criminal proceedings against ruggers may deter them, so long as they can be found and the relevant police force is prepared to take a strong line. But what of the lost investment? “Depending on jurisdiction, investors may or may not get compensatory orders upon conviction, and not necessarily for the full amount of their loss,” says Clyde & Co.
“The alternative is a civil action. The questions for initial consideration will include what are the causes of action; where are the NFTs and the funds located; where are the hackers located; do the hackers have assets to satisfy any judgment if the NFTs and/or funds cannot be located; what is the most convenient forum to bring a claim and will there need to proceedings in aid elsewhere; what governing laws will be applied; how will any judgment be recognised; will interim relief be needed; how long will this all take and how much will it all cost.
“Civil claims are coming. It may take a while for the national courts to find the best solutions to these emerging problems, but find solutions they will. Our experience in the UK is that judges don’t sympathise with fraudsters, and will deliver effective justice where possible. The courts will catch up and the learning curve will be met. Who would have thought, for example, freezing orders could be validly served via Facebook?
“A potential combination is the pursuing of criminal and civil actions, possibly in different jurisdictions. These can often complement each other effectively, but care needs to be taken to ensure investors are not subordinated in that process.”
What’s next?
The early years of an emerging technology inevitably produce stumbling blocks that users, developers and investors must overcome. As with the wider crypto space, stronger Know Your Client (KYC) and Anti-Money Laundering (AML) provisions need to be put in place in order to prevent projects rug-pulling and teams disappearing with investors’ money.
“The NFT platforms and marketplaces need to do more in terms of due diligence. Projects should be required to produce a coherent business plan; minting funds should be held in escrow until appropriate background checks are complete; more frequent and in-depth background checks on teams should be implemented; and a project should be subject to additional and more stringent due diligence requirements if mint funds received surpass a specific amount,” advises Clyde & Co.
“There will be stronger safeguards; but we have the expertise on hand to help investors with their rights to pursue effective recourse and take the fight to the ruggers. As both measures combine to thwart the ruggers, this may cause them to think twice about cheating their investors in the first place.”
In Crypto: FTX founder Sam Bankman-Fried arrested in Bahamas
Cryptocurrency shorts
Sam Bankman-Fried will spend Christmas behind bars after a bail application in the Bahamas was rejected. The federal charges against the former FTX CEO include conspiracy to commit money laundering, conspiracy to commit wire fraud on customers and lenders, conspiracy to commit commodities and security fraud, separate wire fraud on customers and lenders, conspiracy to defraud the United States and violating campaign finance laws. The Securities and Exchange Commission and the Commodity Futures Trading Commission have both filed separate charges against him.
Chief restructuring officer and current FTX CEO John Ray told a United States House Committee hearing focused on the collapse of FTX exchange that the company had “no record-keeping whatsoever”. It used bookkeeping software QuickBooks to track its multi-billion-dollar portfolio. “This is really just old fashioned embezzlement. This is just taking money from customers and using it for your own purpose. Not sophisticated at all,” he said.
Cryptocurrency exchange Binance has seen outflows of more than $1.14 billion in the last 24 hours, according to CEO Changpeng Zhao. He tweeted: “We have seen this before. Some days we have net withdrawals; some days we have net deposits. Business as usual for us.I actually think it is a good idea to ‘stress test withdrawals’ on each CEX on a rotating basis.”
The world’s largest stablecoin issuer, Tether, has pledged to eventually stop the practice of lending out funds from its reserves.
Fortnite maker Epic Games is launching an open-source Web3 programming language, Verse, which includes call-by-value functionality.
DOGAMÍ, a Web3 game for NFT pet companions, has completed a $14 million seed round with a $7m extension to expand its range of Web3 games for mainstream audiences.
Crypto prices
The overall market cap of the 22,000 coins is at $871 billion at the time of writing (7am UK), a 3% rise in the last 24 hours.
For round-ups of recent cryptocurrency news developments, click here.
For valuations of the top 100 coins by market cap in US dollars, plus 24-hour price change, see below.