Combatting Fraud And Corruption In The NFT Market – Fin Tech
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On Oct. 6, 2021, the U.S. Department of Justice (DOJ) announced
the creation of a National Cryptocurrency Enforcement Team to
tackle investigations and prosecutions of criminal misuses of
cryptocurrency.1 As the non-fungible token (NFT) market
continues to expand, DOJ’s heightened focus on cryptocurrency
has begun to encompass NFTs. Just as with any other market, a
particular focus of DOJ’s efforts will be to identify and
prosecute fraud. At the same time, fraudulent activity is becoming
increasingly common in the NFT market.2 This paper
provides an overview of common fraud typologies in the NFT market
and steps NFT market actors can take to protect themselves from
becoming victims of fraud or unwittingly facilitating fraud.
Recent Examples of Fraudulent Activity in the NFT Market
The following recent examples show some of the NFT fraud
typologies that have arisen to date:
- In August 2021, a fake Banksy NFT was sold for £244,000
on a now-deleted page on the artist’s website following a hack.
After wide press coverage, the hacker eventually returned most of
the money to the buyer.3 In September 2021, insider
trading allegations shook the NFT space after leading NFT
marketplace OpenSea confirmed reports that an employee purchased
NFTs they knew were to be featured on the company’s front page
before they appeared publicly only to resell them at a higher
valuation after the NFTs were featured on OpenSea’s
site.4 - On Jan. 10, NFT marketplace LooksRare launched as a competitor
to OpenSea, attracting high volumes with its token incentives and
trading rewards; however, on Jan. 30, Cointelegraph reported that a
very small group of traders executing trades worth hundreds of
thousands of dollars between their own wallets reaped most of the
trading rewards.5 - On Jan. 15, NFT artist Liam “Sharpy” Sharp announced
that he would be shutting down his DeviantArt gallery due to piracy
of his NFTs and the cumbersome process artists must undertake to
report every instance of piracy to the NFT
platform.6 - Between Jan. 23 and 27, a series of blockchain transactions
show that cryptocurrency used to purchase an NFT of Melania
Trump’s first official state visit came from a wallet that
belongs to the entity that originally listed the project for
sale.7 - On Jan. 24, Elliptic identified at least five attackers who
exploited still-active old marketplace ads to purchase $1.1 million
in NFTs from OpenSea users – well below market value –
later selling them for multiples of the purchase price. At least
one of the attackers sent his profits through a mixing
service.8 - On Jan. 27, VICE reported that some NFTs on OpenSea were
utilizing custom code to capture viewers’ IP addresses,
potentially for the purpose of mining other identifiable
information of the viewers.9 - On Feb. 2, Chainalysis published a study reporting NFT wash
traders made nearly $8.9 million in profits, likely from sales to
unsuspecting buyers who believed the NFT they bought had grown in
value. The study also reported that $2.4. million from illicit
addresses were sent to NFT marketplaces for money laundering
purposes, including significant amounts of stolen funds –
even those with sanctions risk.10 - On Feb. 11, NFT marketplace Cent announced it was suspending
sales of NFTs due to rampant NFT fakes and plagiarism and may
introduce centralized controls as a short-term measure to reopen
the marketplace.11 - On Feb. 14, HM Revenue & Customs of the British government
seized its first NFTs as possible proceeds of money-laundering
methods in a suspected £1.4 billion value-added tax (VAT)
fraud in which two individuals tried to claim back more VAT than
they were owed using stolen identities, unregistered phones and
false invoices to hide their identities.12 - On Feb. 19, OpenSea announced it was investigating a potential
phishing campaign that took advantage of its planned smart contract
upgrade to steal NFTs of at least 17 NFT holders.13 - On March 24, DOJ charged two defendants in connection with the
execution of a $1 million NFT “rug pull” scheme. The
defendants created and sold NFTs before abruptly abandoning the
project, shutting down the website and making off with
investors’ money just hours after the NFTs sold out.14 - On April 25, Cointelegraph reported that Yuga Labs, developer
of the Bored Ape Yacht Club NFTs, fell victim to hackers who
breached its social media account and shared phishing scam links to
a website that was used to steal NFTs from users who connected
their MetaMask wallets to the website. Approximately 100 NFTs, with
an estimated value of more than $40 million, were stolen during the
attack.15 - On April 28, the Joint Chiefs of Global Tax Enforcement (J5),
an intergovernmental organization dedicated to combating
transactional tax crime, issued an intelligence bulletin entitled
“J5 NFT Marketplace Red Flag Indicators” that provides
guidance on NFT fraud indicators and how to improve fraud detection
in the NFT market.16 - On May 11, securities regulators in five states filed
enforcement actions against Flamingo Casino Club, a metaverse
casino with alleged ties to Russia, ordering the casino to halt the
sale of its NFTs. Among other things, the regulators alleged that
Flamingo Casino Club sold unregistered “securitized
NFTs,” purportedly giving would-be investors a portion of the
casino’s profits; used fake information to conceal the
identities of its principals; and falsely claimed to have
partnerships with and endorsements from various high-profile
businesses, including a brick-and-mortar casino in Las
Vegas.17 - On June 1, DOJ published a press release announcing the
unsealing of an indictment charging a former OpenSea employee with
wire fraud and money laundering “in connection with a scheme
to commit insider trading.” The indictment relates to reports
confirmed by OpenSea in September 2021 and alleges that the former
employee used confidential information to purchase NFTs with the
knowledge that the NFTs would be featured in the future on the NFT
marketplace’s homepage, at which time the NFT value would
likely increase and the former employee would gain a personal
financial benefit.18 - On June 4, CoinDesk reported that Yuga Labs suffered a hack of
its social media server, with hackers stealing NFTs valued at
approximately $360,000 via a phishing scam posted on the social
media channel.19 - On June 30, DOJ announced criminal charges against a defendant
who allegedly orchestrated an NFT rug-pull scheme by abruptly
ending a purported NFT investment project, deleting its website and
absconding with investors’ money. The defendant and his
coconspirators allegedly then laundered $2.6 million of
investors’ funds through “chain hopping,” a form of
money laundering in which one type of coin is converted to another
and funds are moved across multiple cryptocurrency
blockchains.20
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Footnotes
1. Press Release, “Deputy Attorney General Lisa O.
Monaco Announces New Cryptocurrency Enforcement Team,” Dept.
of Just., Oct. 6, 2021, available at https://www.justice.gov/opa/pr/deputy-attorney-general-lisa-o-monaco-announces-national-cryptocurrency-enforcement-team.
2. The Chainalysis 2021 NFT Market Report, https://go.chainalysis.com/nft-market-report.html.
3. “Fake Banksy NFT sold through artist’s
website for £244k,” Aug. 31, 2021, available at https://www.bbc.com/news/technology-58399338.
4. “Largest NFT marketplace admits the fix was in,
surprising no one,” Dec. 11, 2021, available at https://sea.mashable.com/tech/17544/largest-nft-marketplace-admits-the-fix-was-in-surprising-no-one.
6. https://www.rediff.com/business/report/is-the-nft-youre-buying-authentic/20220115.htm.
8. https://www.elliptic.co/blog/bug-allows-nfts-worth-over-1-million-to-be-stolen.
9. https://www.vice.com/en/article/xgdvaz/nft-steal-ip-address-opensea.
13. https://www.coindesk.com/business/2022/02/20/opensea-investigating-exploit-rumors-as-users-complain-of-missing-nfts/;
https://www.coindesk.com/business/2022/02/21/opensea-says-phishing-attack-impacted-17-users/.
15. https://cointelegraph.com/news/bored-ape-yacht-club-nfts-stolen-in-instagram-phishing-attack.
16. https://www.irs.gov/pub/irs-utl/j5-media-release-4-28-2022.pdf.
17. https://www.ssb.texas.gov/sites/default/files/2022-05/FlamingoPressRelease.pdf.
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