A JPG of Beeple’s collected works was sold recently at a Christie’s auction for a cool $69.3 million. Yes, you read that right, a JPG. The musician Grimes has raised a total of $6million through auctioning off her digital works and Jack Dorsey famously sold his first tweet as a digital token for $2.9 million. Welcome to the world of the NFT: the latest crypto-craze sweeping the art and e-commerce world.
Non-fungible tokens or “NFTs”, are cryptocurrency’s trendier, more overhyped, and less tangible next-door neighbour. Essentially, NFTs are digital assets that operate on the blockchain. Each NFT has a unique digital signature recorded on the digital ledger. They are traditionally used to commodify work created digitally including artwork, music/audio files and video games. NFTs differ from traditional cryptocurrency because each NFT is unique and therefore not interchangeable with other NFTs in the same way that fungible tokens (such as bitcoin) are. Importantly, you are not buying ownership of the piece of art itself but the metadata attached to it as an NFT. Perhaps a more straightforward way of conceptualising it is to imagine that you are purchasing a digital deed of ownership that attaches to the digital work of art.
The crypto-market has been dominated in the first quarter of 2021 by the sale of NFTs. With celebrity artists like Damien Hurst and Banksy entering the fray, or those ubiquitous memes becoming a source of unexpected wealth through pure notoriety (“Disaster Girl”, Zoe Roth auctioned off the original copy of her meme as an NFT for $500,000), the market is proving potentially lucrative and shows no signs of slowing down. However, where there is money, new platforms and a lack of regulation, scams will follow and the art world is no less vulnerable to the cyber-fraud pandemic that is gripping the remote world.
A risky business?
NFTs should in theory, have a positive influence on the art world, an arena which has long been synonymous with fraud. NFTs provide a form of authenticity to digital art, affording artists the opportunity to use these online platforms to auction their work which has its own unique token. Theoretically, this should assist in preventing forgeries and add an additional layer of transparency as it is impossible for these digital assets to be modified, pirated, reversed or destroyed due to the unique digital ledgers that are used to record NFT transactions. However, as we have seen previously within the crypto-sphere, there is still plenty of scope for scammers to take advantage of a new market which is without the necessary systems and controls to make it infallible to corruption.
Counterfeits and copycat platforms
Forgers and imitators are piling onto the scene looking to make a quick profit. NFTs are traded through live online platforms, many of which currently have very limited due diligence and a real issue is the failure of these platforms to ensure the authenticity of the digital work prior to it being sold. Anyone can “mint” (the process of tokenising the work) anything as an NFT, which has led to a rampant trade in rip-off work. An individual purporting to be Banksy has amassed over $1million from NFT sales. There is no system requiring the individual minting the work to prove they are the true owner and potential purchasers should be alive to the fact that there is a high possibility of fraudulent miss-selling occurring. Similarly, for irate artists and purchasers alike, tracing the individual who may have minted an artist’s work can prove problematic as the transaction exists on the blockchain, providing the scammer with a welcome degree of anonymity.
There is also the risk of fake platforms whereby purchasers mistakenly enter their valuable currency into an illicit platform only to find out that platform has disappeared without warning, and they are left with neither the NFT they attempted to purchase, nor the cryptocurrency used to purchase it. Without significant improvement to the systems and controls in place on trading platforms, it is essential for purchasers to ensure they carry out their own provenance investigations prior to buying in order to avoid counterfeit purchases. Failure to have appropriate controls in place to confirm the legitimacy of the digital work and its seller will only negatively impact the NFT market in the long run, as much of the value for buyers lies in the fact that they are purchasing a work that is both unique and scarce.
Inevitably, where there are commodities being traded online, hacking cannot be ignored and the crypto-sphere is no stranger to this form of theft. Digital wallets are susceptible to being hacked and the NFTs held within stolen. Nifty Gateway, a prominent digital art auction platform, was recently compromised by hackers who were able to transfer purchased NFTs from individual user accounts and promptly sell them on to other NFT purchasers on alternative platforms (Nifty Gateway strongly disputes that the platform itself was compromised and points to the lack of 2 factor authentication on the individual users’ accounts). Once sold to a different platform, Nifty Gateway lost control of the NFTs, which proved ultimately irrecoverable as it is the platform itself that holds the key associated with the NFT.
One of the latest trends in the market is the fractionalisation of NFTs. By fractionalising these tokens, you allow investors with smaller levels of wealth to pool their resources and be part of the market through buying an interest in an NFT. It essentially creates additional liquidity by enabling purchasers to trade their shares in the NFTs on market platforms. By opening up the market and making it increasingly accessible to the everyday consumer, it throws up, amongst other things, whether fractionalised NFTs should be classed as securities and therefore subject to financial regulations and naturally, the tax implications that come with such status. Whilst the current position is that a single piece of art attached to the blockchain is not a security, the burgeoning growth of fractionalised NFTs within the market and the clear potential for abuses points to regulation being likely in the future.
Like all cyber-fraud, the global reach and anonymity of online markets create additional challenges when trying to identify fraudsters. Until regulatory bodies catch up, purchasers are at increased risk of falling victim to fraudsters who have tapped into the market with alarming ease. Lawyers need a robust legal framework to deal with this emerging market and effective tools available to them to track the identity of fraudsters if they are to have any hope of securing recovery.
Weapons in the arsenal?
Whilst the world awaits the introduction of proper scrutiny and governance for these new and often obscure technologies, the role of litigators in utilising the legal remedies available to trace and recover these assets becomes ever more relevant. Reassuringly, the English Judiciary have proven themselves to be adept at developing and adapting the law to accommodate advances in technology, demonstrating a clear desire to make use of the tools and remedies available within the English legal system to provide appropriate relief to victims seeking the assistance of the Court.
Emergency relief such as proprietary injunctions, worldwide freezing orders and ancillary third party disclosure orders are commonplace in fighting fraud. The landmark case of AA v Persons Unknown & Ors , was the first within the English and Welsh Courts to determine that crypto-assets are “property”, paving the way to allow the English Courts to grant proprietary injunctive relief and protective orders on behalf of the applicant.
There is no reason why these same remedies should not be available in cases of NFTs but as ever, delay is the primary impediment to recovery for victims of fraud. Applications can be made without notice and heard in private to prevent fraudsters from being put on notice and disposing of the assets before enforcement is possible. Similarly, it is possible to make use of civil recovery instruments such as Bankers Trust orders against the live platforms themselves, which require a third party to disclose information about the identity of property and details of the individuals handling such property held which may become the subject of a Freezing Order. Clearly, this is likely to be most effective in the event that relief can be obtained before the fraudster has removed or sold the NFT from the platform which further highlights the need for swift action to be taken where possible.
It is worth noting that during the pandemic the Courts have been cognisant of the fact that information and evidence gathering, particular in cases of cross-border fraud, has been significantly more difficult and they have used their discretion to factor this into applications for relief. Failure to give due process to cases will make enforcement of judgments more difficult in the long term and applicants should balance the need for swift relief against the requirement to carry out sufficient investigative action at a preliminary stage.
There is much debate about whether NFTs are here to stay. Critics will continue to make comparisons to the “Dotcom Bubble” and refer to the digital asset market as little more than an elaborate Ponzi scheme. Nevertheless, given the formidable growth of the market in the art world especially in the last year or so and the clear opportunity it presents for cyber-fraudsters, it is a trend lawyers cannot afford to ignore. Where there is technological innovation, legal questions will inevitably follow and the rapid rise of disputes concerning crypto-assets means that this is a market practitioners will have to acquire a comprehensive understanding of, and quickly.