Fraudsters are always hunting for new ways to part people from their money, and the world of digital assets is no exception.

Non-fungible token fraud in the UK has risen sharply in the 12 months to 30 September, and the value of reported NFT fraud surged almost tenfold from £421,000 ($495,779) to £4.2 million, according to a report by Pinsent Masons, the law firm.

The number of individual fraud reports relating to NFTs has increased by almost nine times from only nine incidents reported in 2020/21 to 78 in 2021/22.

The rise of these tokens adds another dimension to the sort of compliance challenges wealth managers, private client advisors and others face. 

NFTs are effectively digital certificates which identify ownership of an online asset, including artwork, photos or videos. These assets are “tokenized” to create a record of ownership on a blockchain. NFTs are traded online. 

Pinsent Masons said the lack of regulation in the NFT and wider cryptocurrency space “leaves investors susceptible to fraud."

(See here for an overview of digital assets and how they affect wealth managers.)

A particularly common type of NFT price manipulation is “wash trading,” whereby those with an ownership interest in an NFT trade it amongst themselves to raise the price before someone else buys it at the inflated price.

In February 2022, HM Revenue & Customs, the UK tax authority, seized three NFTs connected to a VAT fraud involving 250 fake companies – the very first time a UK authority had seized an NFT. The fraud was worth £1.4 million. HMRC secured a court order to detain crypto assets worth £5,000 and the NFTs that had not been valued at the time of seizure.

US action
In March this year, the Securities and Exchange Commission charged two individuals with conspiracy to commit money laundering through defrauding purchasers of NFTs. In a million-dollar scheme, the SEC’s complaint involved the pair attracting millions of dollars’ worth of investment and then abandoning the project – known as a “rug-pull.” 

The individuals also planned to launch a second NFT which would have allegedly generated $1.5 million.

The SEC announced in May 2022 that it was doubling its Crypto Assets and Cyber Unit to police wrongdoing by fraudsters. In addition, the creator of Bored Ape Yacht Club NFTs, Yuga Labs, is allegedly under SEC investigation as to whether the sale of their NFTs were akin to a stock offering and therefore should have been subject to securities regulation.

NFTs soared in popularity during 2021, partly driven by interest in the Bored Ape Yacht Club NFTs and those created by digital artist Beeple. Last year, an NFT created by Beeple sold for a record $69.3 million. Since then, the number of active NFT buyers has fallen by 94.8 per cent between January 2022 and July 2022 and average NFT value has fallen by 86.6 per cent during May 2022 alone.

“Fraudsters have targeted the NFT market to exploit investors’ enthusiasm for get-rich-quick schemes based on digital assets,” Hinesh Shah, senior associate forensic accountant at Pinsent Masons, said. 

“Fear of missing out has overridden many investors’ scepticism. During the cryptocurrency bubble almost nothing was `too good to be true’.”  

“The speed at which the NFT market has grown has taken enforcement bodies by surprise and a lack of clear regulation on the market means authorities are unsure if it falls within their remit. Fraudsters have viewed this as an opportunity to take advantage of, particularly in the short-term, whilst regulators are still grappling with the appropriate mechanisms of regulating digital assets,” Shah said.

“While the drop in the NFT market may discourage investors seeking a quick buck and avoids the possibility of these individuals being defrauded, fraud often gets discovered during a downturn in the market. This signals a warning to any unscrupulous market participant seeking to exploit the space’s lack of regulation to defraud inexperienced investors,” Shah added.