NFTs: Magic beans, or just plain lemons?
NFTs are hot – no doubt about that. Chainalysis reports that users sent at least $44.2 billion worth of cryptocurrency to ERC-721 in 2021, and more than 6,000 NFT collections on OpenSea have undergone a transaction.
The uses are abundant and the money changing hands is substantial.
But there are few things that are not quite right… not everyone makes money. Chainalysis found that only 28.5% of NFTs purchased during minting and then sold on the platform result in a profit and that only 20.8% of users who don’t make the whitelist make a profit.
Some artists have ended up losing money because of gas costs. Aleksandr Hovhannisyan is highly critical and points out the many risks related to NFTs.
Losing money is one thing, but two big issues threaten to undermine the whole industry – washtrading and money laundering.
Wash trading is a series of trading activities involving the same trader buying and selling the same NFT, creating an artificially high trading volume and a manipulated market price for the NFT. Chainalysis found the value sent to NFT marketplaces by illicit addresses jumped to $1.4 million in Q4 2021.
The vast majority of this activity came from scam-associated addresses sending funds to NFT marketplaces to make purchases. Roughly $284,000 worth of crypto was sent to NFT marketplaces from addresses with sanctions risk in Q4 2021.
110 profitable wash traders have collectively made nearly $8.9 million in profit from this activity, most likely derived from sales to unsuspecting buyers who believe the NFT they’re purchasing has been growing in value, sold from one distinct collector to another.
A CryptoPunk was recently sold for $532 Million. Larva Labs said on Twitter that “someone bought this punk from themselves with borrowed money and repaid the loan in the same transaction”. Chainalysis found 262 users who have sold an NFT to a self-financed address more than 25 times.
Money laundering activity is a risk with NFTs. Some have even described NFTs as the “best money laundering method in the cryptocurrency world”.
Medium describes how NFTs can be used to launder money. Someone who wants to launder money, creates two separate accounts on an NFT marketplace like OpenSea. One of the accounts is under the real name and auctions off a piece of art. The other account is used to purchase the artwork, funnelling illegal funds into another wallet under the guise of a seemingly legitimate transaction.
The U.S. The Department of the Treasury highlighted the risk that NFTs can be used to launder funds. This includes “wash trading” where criminals purchase an NFT with illicit funds and proceed to transact with themselves to create records of sales on the blockchain. The NFT could then be sold to an unwitting individual who would compensate the criminal with clean funds not tied to a prior crime.
But there’s more?
Are you buying an NFT, or really magic beans? Caveat Emptor!
Clarity is needed on the difference between owning an NFT and owning the right to exploit a copy of a digital work covered by copyright. Do you know the IP rights associated with a NFT sale? Any artist, online marketplace, or other vendor selling or reselling rights to NFTs should clarify those rights.
NFTs can be further programmed beyond the basics of ownership and transferability to also include a variety of other applications and functionality, including those linking the NFT to some other digital asset. But do you know what those rights are?
Technically, NFTs are protected under copyright. Harry Richt, a lawyer based in New York City, pointed out l that “by default, the author of an NFT retains all the exclusive rights, including the right to create copies of the work”.
Max Dilendorf argues that the intellectual ownership of NFTs is “a contractual question, depending on the platform” you buy the NFT from. An NFT cannot exist without an underlying digital asset. Although it has not been tested in court, copyright protection likely only exists for the asset to which the NFT attaches, not for the NFT itself.
Dan Olson outlines that with a URL pointing to the file and it is possible to just swap out what’s being hosted at the end point of that URL. There is a loose link between an NFT and the asset it refers to.
Others are profiting from NFTs that don’t belong to them. They download someone else’s image, create their own NFT to associate with the copy (which may have been very slightly modified), and then try to sell it on a marketplace like OpenSea or Nifty Gateway. This is known as “copyminting”.
Some NFT marketplaces only function with certain blockchains, what if that platform has limited liquidity or ceases to operate?
NFTs May Represent Counterfeits, because unless you know the seller, you have no way of verifying the authenticity of the listed item. To illustrate, a collector bought a fake Banksie NFT or GBP 244,000.
We want people to benefit from this market, but how do you know if you are buying magic beans? There are currently no standards, and no common network agreed to. Regulatory oversight of NFTs is lagging behind, making the NFT market a temporary safe haven for criminals. But this will catch up. The 2021 Infrastructure bill now requires that transactions involving digital assets exceeding $10,000 be reported to the IRS, this change makes it much more difficult for individuals to launder large sums of money using NFTs.
Can the industry self regulate? Blockchain data and analysis makes it easy to spot users who sell NFTs to addresses they’ve self-financed, so marketplaces could take steps to consider bans or other penalties for offenders.
Until recently, buying an NFT was a serious challenge for crypto newcomers.
Users had to create a cryptocurrency wallet, link it to the NFT platform and add the necessary amount to their cryptocurrency wallets before they could make a purchase.
NFT marketplaces that use the Ethereum network require prospective buyers to buy Ether, the native cryptocurrency of Ethereum, to buy NFTs in these marketplaces. Innovators are solving this – recently, MoonPay has introduced an NFT checkout tool that will allow investors to buy digital art and collectibles online using credit cards and other traditional forms of payment. Coinbase also announced a partnership with the payment service Mastercard to allow its users to buy NFTs using a Mastercard. This is good news for those who don’t want the headache of buying crypto.
Education and ease of user experience are barriers to wider adoption, and enabling consumers to actually understand what they are buying.
Don’t get me wrong, NFTs are an amazing innovation and here to stay, and we will see innovation and adoption across a wide range of use cases.
But in this crazy experimental phase, people will get hurt. We in the ecosystem can help prevent that, we need to call it out, to self regulate and not cover up illegal activity.
Did you buy an NFT, magic beans or really just a lemon?