Long reads

NFTs: New asset on the block

Lydia Danon

Lydia Danon

Partner and solicitor advocate, Cooke, Young & Keidan LLP

Non-fungible tokens (NFTs) are the new crypto asset on the block(chain) – are they all they are cracked up to be and should we be investing in them, or giving them a wide berth? The NFT market is younger than the COVID pandemic.  Some say the market has boomed because of the virus.  We have (a lot) more time on our hands to make frivolous memes and more money in our pockets to spend on them. But will the NFT craze outlive that other pathogen taking the world by storm? 

Step by step

At a high level, an NFT is a unit of data stored on a digital ledger (blockchain) which certifies that a digital asset is unique. Unlike cryptocurrencies, which can be exchanged like for like, NFTs are not interchangeable and can be used to identify a unique asset, either in the real or digital world. The token lives in a decentralised state, it can’t be changed or amended, it is what it is.

An NFT generally comes with contractual provisions often in the form of a smart contract. These are self-executing contracts with the terms of the agreement written into the lines of code. The code controls the execution, and transactions are traceable and irreversible. NFTs are sold on online platforms and have been used to verify ownership of digital works of art, collectibles, music and the aforesaid memes. They do not typically give the buyer the actual asset or copyright to the asset, but they do allow artists to get creative. Perhaps the most famous, the right to display a digital artwork via an NFT was sold by the digital artist Beeple for $69 million in March 2021.

In July 2021, Damien Hirst launched “The Currency’ project which allowed 10,000 customers to purchase an NFT with one of his spot paintings as the underlying asset, for the bargain price of $2,000. Each artwork was nearly identical (so unique – just – albeit some pictures are rarer than others), signed, numbered and prepared on specially treated paper so not easily forged. Once purchased, Hirst gave his customers carte blanche to do with the NFTs as they wished for a specified period - they could be retained, traded, sold, or enjoyed. But after two months following the final sale, the then holder of the NFT has to choose whether to keep the NFT or the artwork, at which point the ‘losing’ asset is destroyed.

The aim of the project is to question the notions of value, joy and worth whilst of course (hopefully) making money for the investors. As at the end of August 2021 sales of the NFTs had reached around £25million. The exchange window for the NFTs/artwork opens on 14 October 2021 and it will be interesting to see which asset will triumph.    

NFTs have also been used in real estate to allow a purchaser to easily access and settle the legal work without the use of intermediaries. It has been suggested that property owners could sell part of their property to a certain number of investors, certify the part ownership via an NFT and then pay rent to the NFT holder. It would seem that anything that can be packaged and has value can be sold through an NFT.

Games

Whilst there are many good things about the NFT market, it also has a dark side.  It is a burgeoning market, open to abuse by fraudsters, preying on the ignorant, the naïve and uninitiated.

In late August 2021, a link (now deleted) to an online auction of a fake Banksy NFT was listed for sale on his official website. The underlying artwork did not look like a Banksy but was named after an authentic work by him. The fraudulent link was sufficient to make the NFT appear legitimate and create a bidding war but the supposed three-day auction was cut short in the first hour when the £244,000 bid by the ironically named “Pranksy’ was accepted by the seller. It turned out to be a hoax (or possibly a PR stunt) and luckily for Pranksy all but $5,000 was returned to him, but the deception shows how easy and swift this kind of swindle can be.  

The most common frauds connected with NFTs are:

  1. Replica or fake NFT online stores: these tend to rely on using similar domain names, designs and logos of legitimate NFT stores to reel the customer in. The stores then sell NFTs that do not exist.
  2. Counterfeit NFTs: these NFTs impersonate original artworks, i.e. certify the authenticity of the underlying asset without the permission of the artist.
  3. Social media scams: fraudsters create fake ‘community groups’ on social media claiming to be the official group of well-known brands in the crypto space. They then direct their subscribers to purchase non-existent or counterfeit NFTs.
  4. NFT wallet hacks: wallets can be kept on the cloud or in crypto exchanges and can be targeted by phishing scams or hacked providing access to the NFTs, cryptocurrencies and cash accounts.
  5. The pump and dump: the fraudsters artificially inflate the price of certain categories of NFTs through false and misleading statements / advertisements, dump them on the market and then the price crashes, leaving investors to pick up the pieces.

There can be less nefarious but by no means less concerning problems faced by NFT investors. Smart contracts are immutable and artists have a habit of drafting their own agreements (i.e. not instructing lawyers to do the job for them (outrageous!) so mistakes and ambiguities are rife, thereby possibly invalidating the contract. It may be that investors are not even aware that they are entering a contract and on what terms.

The digital platform Nifty Gateway has recently found itself on the wrong end of a High Court claim over the sale of Beeple’s NFT ‘Abundance’. Investor, Amir Soleymani was unsuccessful in his bid for the work, which apparently went to Taylor Gerring (Ethereum’s co-founder) for £1.2 million. Mr Soleymani was later ‘shocked’ to learn that as the second highest bidder, he was required to purchase a second edition of the NFT, for the princely sum of $650,000. Following his refusal to pay he was blocked from the platform and had 100 NFTs (worth millions of dollars) frozen. Mr Soleymani argues that the terms and conditions he had signed up to in February, had been amended in April (prior to the auction) and the true nature of the auction and what that meant for ‘unsuccessful’ bidders was not drawn to his attention. It seems that Nifty is pursuing arbitration proceedings in New York. The claim will be watched with interest, but it shines a light on the imbalance of power between the investor / collector and the platform.

Hangin’ tough: Is recovery an option?

What happens if an investor is duped along the lines described above – can he recover the cryptocurrency typically paid for the NFT? A key issue is that anyone can make an NFT provided they have an Ethereum wallet (there are other platforms but Ethereum is viewed as the market leader) and the funds to pay a hefty energy bill (like cryptocurrencies NFTs are energy intensive). The NFT market place is unregulated (unless the particular NFT can be characterised as akin to money) and there are only very basic checks required by the platforms to validate whether the person selling the ‘authentic’ work are in fact the correct owners. Whilst parties can track transactions on the blockchain, it does not require parties to attach their identities to a transaction so it can be very difficult (if not impossible) to trace those who are in breach of copyright. 

As for tracing cryptocurrencies, it is possible to use specialist blockchain investigation firms to follow the ‘funds’ to digital wallets held on a platform/exchange. English law provides a range of remedies against exchanges (just as they would banks and other intermediaries) who unknowingly receive misappropriated or stolen cryptocurrencies. The English courts have taken a pragmatic approach and classified cryptocurrency as ‘property’ notwithstanding that it can neither be possessed in a tangible sense, nor can it be enforced by a right to sue. This means remedies which include Norwich Pharmacal and Bankers Trust orders, freezing and proprietary injunctions are available to preserve assets and assist in the identification of the fraudster. One would think that these traditional methods could be applied to NFTs. Like any fraud, the victims must act swiftly if they are to have any chance of recovering their assets.  

Step by step: How to invest in NFTs

As a lawyer, I am naturally risk averse and so I wouldn’t go near an NFT with a 10ft block chain. NFTs are a highly speculative investment and the current market is showing all the hallmarks of a bubble. Expect it to burst. However, if you are thinking of taking the plunge, below are some pointers which may make the investment run a little more smoothly.

  1. Like any investment you need to do your due diligence. Research the auction site to make sure it is legitimate, look to see if the ‘real’ artists have announced sales of their NFTs, or look at credible third-party sources to verify the authenticity of what is being offered. But remember, you can’t believe everything you read on social media. FAKE NEWS ALERT.
  2. Read the fine print of the contract – what are you actually getting with the NFT and from the auction site selling it. If there are updates to the terms and conditions, whilst it might be a pain, read them.
  3. Don’t give out passwords, keys, bank details etc. and certainly don’t answer any questions on Facebook which aim to get the name of your first pet and the street you lived on as a child. Fraudsters use algorithms to piece information together to hack in to your system, your digital wallets and steal your NFTs.
  4. If you are being rushed to place a bid, or there is very limited time in an auction, chances are it is a fraud. Like any push payment fraud, criminals like to act quickly and run off with the proceeds. Don’t be pressured into making a bid or paying money over.
  5. Don’t invest more than you are willing to lose. It is impossible to predict what the next big NFT hit will be, so don’t try to pre-judge it. Enjoy the experience and invest in the NFT for what it is, not what it might be.

 And finally:

(The author has not turned this into an NFT).

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