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NFT Fraud: The Red Flags You Need to Know About

By Mark DiMichael, Gregg Wildstein .

There have been many reports in the media of dramatic returns earned by initial investors in cryptocurrency, non-fungible tokens (NFTs), and blockchain technology. As a result, the potential opportunity for quick/easy money has created a frenzied market that is ripe for fraudsters and unscrupulous investment promoters and several creators and marketplaces have been accused of NFT fraud and schemes.

One of the early and most interesting NFT projects was Crypto Punks in 2017. Crypto Punks were created by two Canadian software developers as 10,000 unique characters, each being their own unique NFT created using computer code. Although Crypto Punks today are well off their highest price, their floor price (the lowest current offer for sale) was 70.1 ETH as of October 6, 2022.

Recent NFT Fraud Attacks

“Pump and dump” scams have become popular in the NFT space. A pump and dump scheme begins with a fraudster acquiring an investment. The fraudster then increases or “pumps” the price of that investment by spreading fake news. The fake news is often spread through social media apps, such as twitter, discord, telegram, and others. At that point, the fraudster will then sell or “dump” their investment for a profit.

Another fraudulent act often seen in the NFT industry are “rug pulls”. Rug pulls are committed by NFT project creators and often leave investors losing their entire investment. An NFT rug pull begins with attempts by creators to lure consumers into buying an NFT. Once the project creators have generated enough sales, they will abandon the project with no warning (reneging on any past promise to NFT investors). Ultimately, the creators stop backing the project, sell their remaining NFTs, and leave the assets price to fall to zero. This type of scam has become popular in the NFT industry since project creators often remain anonymous. For example, many NFT industry influencers and creators are only known by their twitter handle, or the name of an NFT they own. Going by an alias allows project creators to often avoid criminal prosecution.

Phishing attacks have also become one of the most dangerous type of scams in the NFT space. Social media sites have become a major interface for the NFT community to receive news and updates, making it useful for fraudsters. Attackers will often advertise new NFT drops or fake giveaways. The ultimate goal of the fraudster is to convince an individual to connect their crypto wallet to an unknown website. The website will then drain the victim’s wallets of all funds. Attackers using this tactic will often create replica websites of popular NFT projects and even take it as far as selling counterfeit NFTs or impersonating a famous NFT artist.

Airdrops are another way that attackers are attempting to commit fraud in the NFT industry. An airdrop is generally a free give-away of a new crypto asset. Many NFT projects give airdrops to members of their community for holding a specific NFT. These airdrops can be new NFTs, or utility tokens that are linked to specific NFTs. Fraudsters will airdrop new crypto assets or NFTs to consumers with malicious computer code embedded in the underlying smart contract, essentially hacking the victim’s computer or cryptocurrency wallet. Individuals concerned about claiming airdrops or interacting with smart contracts could create a new wallet to interact with an unknown project or website to reduce the risk of loss.

While NFTs are a recent development, fraudulent investment schemes are very old. In fact, the U.S. Securities and Exchange Commission (SEC) was created in 1934 in part to protect investors from these types of scams. However, the fast pace of NFT growth has left the SEC struggling to catch up.

NFT Red Flags

  1. Forecasts of unreasonable returns on investment: No investment is without risks. Unscrupulous promoters will often tout guaranteed profits or will state that the NFT is very similar to other historical investments that were highly profitable.
  2. Quickly thrown together roadmap and promotion materials: Unscrupulous promoters will often quickly prepare marketing materials before moving onto a new scam. Additionally, they may have little or no advanced knowledge in computer applications and processes. This will often result in promotional materials that have little or no technical information about how the token operates. Additionally, the company website may be bare bones or non-existent.
  3. The ability to purchase with a credit card / bank account: NFT purchases use cryptocurrency and often require you to connect a crypto wallet. If a project is asking you for credit card or bank account information, this is a major red flag.
  4. Fake or non-existent project team members: Although many NFT project creators remain anonymous, it is still important to investigate the team who created the project. Anonymous NFT creators often have followings on social media. It is important to make sure the creator, weather anonymous or not, is active and engaging with the project and community members. An NFT creation team providing little to no updates to their community can be a major red flag.
  5. Celebrity endorsements: The celebrity endorsements could be fake, and the actual celebrity may have no idea that their name or image is being used to promote the NFT. On the other hand, the celebrity endorsement could be real. However, individuals should not make investment decisions based on the recommendation of their favorite reality star for example. Celebrities/athletes usually have minimal financial knowledge, if any, and there are many examples of celebrities/athletes that have been duped in the past by unscrupulous friends, promoters, and business managers. NFT project creators have even been targeting celebrities to promote their project and help speed up the process of a rug pull or pump and dump scam.
  6. One-time only deals or discounts for purchases by a certain date: While many legitimate NFTs offer reduced prices for early investors, this is also a technique used by unscrupulous promoters so investors will rush to invest, without fully considering the risks of the investment.

Investors should be on the lookout for these NFT red flags and should perform significant research on new investments before committing money. If an investment sounds too good to be true, it probably is.

For more information, please contact Gregg Wildstein at gwildstein@citrincooperman.com and Mark DiMichael at mdimichael@citrincooperman.com.

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