NFTs are New Fraud Types

I bought a non-fungible token (NFT) the other day. Not as an investment, I hasten to add. The market for these tradable, from cartoon apes to artsy doodles (as the FT frames them) has collapsed in recent weeks. The average selling price of an NFT has has dropped by around half since their peak before Christmas and volumes on OpenSea, the biggest NFT marketplace, fell by 80% over the last month. I think the line of mug punters waiting for their picture of a chimpanzee with sunglasses has evaporated.

There are those of us who appreciate art rather than speculation, though, so I went to the aforementioned OpenSea to buy something nice. In case you are interested, it is a cartoon from the talented artist Helen Holmes. In case you are an art buyer, this is the one that I bought. It is from her “originals” collection and is now proudly on display in my wallet for all to see.

11 cashorcharge

I commission Helen to draw the cartoons that I use to illustrate my articles on Forbes, so I can testify at first hand that she is real, that the cartoons are originals created by her and that I have the right to use them due to our own agreement. And, I am happy to say, that if anyone buys one of them, the money goes to her, the deserving artist. As it turns out, this makes “my” NFT one of the small number of legitimate examples of same, because recently OpenSea said that over 80% of the NFTs created for free on the platform are “plagiarized works, fake collections, and spam”.

(I say “my” NFT, although owning an NFT doesn’t give me any rights in the underlying intellectual property, which still belongs to Helen, or unique access to the image itself which anyone can download just be right-clicking on the picture above.)

Even the NFTs that are not fakes and frauds are often dodgy, to say the least. I include in this category the NFT of an X-ray of one of the survivors of the Bataclan massacre in Paris, which was offered for sale for $2,776 by the surgeon who treated her. And this isn’t about OpenSea, it’s about the entire market. A recent study found that “the top 10% of traders alone perform 85% of all transactions and trade at least once 97% of all assets”. Looking at the numbers, the top 10 percent of “buyer–seller pairs” are as active as everyone else combined. It is market almost completely captured by whales.

When the platform that sold the NFT of Jack Dorsey’s first ever tweet for three million American dollars halts most transactions because counterfeit creators were selling tokens of content that did not belong to them, then I think we can all agree that there is a fundamental problem in the digital assets market.


It looks as if NFTs are providing a platform for innovation in fraud as well as innovation in creative works. One of the most common kinds is what is known as “wash trading”, where groups of fraudsters trade an NFT between themselves, for an ever-higher price, until someone who is not part of the group and who thinks that the price is real (in colloquial English investment banking parlance, such individuals are known as “mug punters”) steps in to buy the “art”. At which point, the group split the proceeds between themselves, rinse and repeat. 

This kind of trading is rampant. OpenSea was recently overtaken in volume by LooksRare. LooksRare financially rewards users for their trading volume, which predictably means rogues gaming the system. Crypto analytics firm CryptoSlam estimated that more than four-fifths of the total trading volume since launching is in fact wash trading.

(Interestingly, a detailed Chainalysis study of the problem discovered a strong asymmetry: Most wash traders have been unprofitable, but the successful ones have profited so much that, as a group, wash traders have profited immensely.)

Having said that NFTs are a platform for innovation in fraud, I am forced to admit that I sometimes admire the ingenuity of some of the crypto hackers/loophole exploiters who have been getting work in this new world. Take, for example, the OpenSea “loophole” that was exploited because some NFT owners were unaware that their old sale listings were still active. These old listings were found, and the NFTs were purchased. This led to the loss of multiple expensive NFTs at rock bottom prices. The problem is that the NFTs were getting sold at old offer prices made when the NFTs were much less valuable. To give a specific example, one attacker paid a total of $133,000 for seven NFTs before quickly selling them on for $934,000 in ETH. (Five hours later this ether was sent through Tornado Cash, a “mixing” service that is used to prevent blockchain tracing of funds.)

As Tom Robinson of blockchain analysis company Elliptic explained, this ingenious (although I have to say, not that complex) fraud then led on to an even more fun fraud because OpenSea sent an email to users who still had old NFT listings, and were therefore susceptible to this fraud. However, cancelling the old listing requires an ETH transaction so the enterprising freelance alternative finance enthusiasts behind the original fraud then created bots to look out for these particular transactions and front-run them to purchase the NFTs before the listing was cancelled. In other words, by trying to be helpful and tell users to cancel the vulnerable listings, the marketplace gave away precisely the information need by the perpetrators to automate their attacks.

Scale and Scope

Not all frauds are particularly complex. An awful lot of money has been lost to very basic frauds such as the “rug pull”, whereby innovative cryptocurrency engineers announce the realise of a fabulous new digital asset that will do amazing things in the future, increase 100x in value in next to no time and cure cancer on the way. The public respond with enthusiasm and deluge the issuers with cash, at which point the issuers vanish, deleting their web site, Telegram chat and phoney LinkedIn profiles on the way. The public let the virtual cats out of the virtual bags and discover that they are left with nothing.

(MonkeyJizz was a scam! Who knew!)

There are frauds, though, that take more advantage of the nature of the new infrastructure. The “honeypot” is one such example. In a honeypot, the programmer of the smart contracts that control a new token inserts surreptitious code to ensure that only their own wallet can sell the tokens. Everyone else’s money is stuck in the honeypot while the scammer who created the tokens can sell at any time.

Mention of honeypots takes us on to the main point. Many of the most notable frauds that abound involve decentralized finance, or DeFi, projects, with more than $10 billion lost to DeFi theft and fraud last year. The ability to automate fraud in the DeFi space is a fascinating and terrifying development because of the sheer scale of the frauds that can be perpetrated but automated fraud is not limited to the web3 world, of course. PayPal (PYPL) recently closed 4.5 million accounts (and lowered its forecast for new customers) after discovering that bot farms were exploiting its incentives. The payments had offered $10 as an incentive to open new accounts, at which point the bot farmers stated tilling the PayPal fields.

The combination of automation and complexity is toxic and needs to be tackled up front. But how? Surely it should be one of the most basic tests of eligibility for a payment account that you are an actual human being! How is it so difficult to ensure that certain transactions are executed by people and not by bots! I hate to say it yet again, but the way forward is through a working, fit-for-purpose digital identity infrastructure. It should not be possible to open an account without an IS_A_PERSON credential, which as I insist on forecasting, will one day be the most valuable credential of all.

Tokens are tulips or teabags or…

Many years ago, at the height of the Dotcom boom, I was involved in a couple of consulting projects advising investment banks on technology infrastructure. I can remember that in one of the teams I worked with at that time had a generic dismissive term for nonsensical dot com startups that had no sustainable business model and were created simply to fleece retail investors in IPOs while rewarding their investment banking chums. This was “”.

Whether it is now politically-incorrect to use the term or not I am not certain (I am sure that social media will let me know pretty quickly) but it still pops up in my head when I read about some new non-fungible token (NFT) jape, which is almost every day at the moment. I’ll see something about a machine generating pictures of chimpanzees with assorted random sunglasses on and just file it away under usedcondoms.eth and think no more about it.

I discovered that used condoms do have a sustainable business model associated with them after all. Click To Tweet

Unfortunately I am going to have to train myself in some new terminology, since I discovered that used condoms do have a sustainable business model associated with them after all. The police in Vietnam discovered a working operation in the province of Binh Duong following a tip off. Instead of praising the freelance prophylactic entrepreneurs for their valuable ecological stand against single-use disposable consumer products, the forces of law and order raided their warehouse and confiscated a few hundred kilos of bags stuffed with more than 300,000 recycled condoms. According to news reports, the condoms had been boiled, dried and reshaped with a wooden prosthesis. The warehouse owner, a 34-year-old woman who said she received a monthly delivery of used condoms from an “unknown person”, came clean on the economics: she got 17 cents for every kilo of recycled rubbers, so the police had confiscated a substantial amount of her dongs (in fact, about a week’s worth at average wage).

I think I’m going to have to choose a more British epithet and ask whether NFTs are going to be another Paypal or another* or whatever.

Listen to the Flower People

Actually, I think a more useful analogy is tulip bulbs. As you will have noticed, discussions about Bitcoin frequently refer to the well-known speculative mania of the Amsterdam “tulip bubble” in the 17th century. But as I pointed out in Forbes last year, that was not a mass market mania but speculation by a small group of rich people who could well afford to lose money. What’s more, when the bubble popped it left behind a more efficient and better regulated financial market that played a significant role in creating the Dutch golden age. So great was the impact of this more efficient financial intermediation that balances at the Bank of Amsterdam became a pan-European currency and, as noted in an Atlanta Fed paper on the subject, the Dutch florin played a role “not unlike that of the U.S. dollar today”.

So, saying that NFTs are like the tulip bubble is, in fact, saying that a relatively small number of people will lose a lot of money, but the long term outcome will be a more efficient financial system, which is pretty much what The Economist meant when it observed that “because tokens can be digital representations of nearly anything, they could be efficient solutions to all sorts of financial problems”.

When I’ve spoken to serious finance people about tokens they have all pretty much said the same thing: when the regulatory structure is in place, they will tokenise everything. Everything.

* Uh oh. I’ve just discovered that there are in fact 27 things to do with used teabags, so I’m going to have to go back to drawing board (well, bath) and come up with something else sharpish.

Tulips, steam and decentralised finance

When we are thinking about where the worlds of Bitcoin and cryptocurrencies, “smart” “contracts” and decentralised finance (defi) will go, it can be helpful to find historical analogies that can provide a shared narrative to facilitate communications between stakeholders and provide foundations for strategic planning. But it’s important to find the right analogies and, even more importantly, to derive the right lessons from them.

For example: people discussing Bitcoin will often refer to the famous “tulip bubble” in 17th century Holland. But if you study this episode, what you discover is not a mass market mania but speculation by a small group of rich people who could well afford to lose money. And you will also see the creation of a regulated futures market that played a role in the financial revolution that contributed to a Dutch golden age which meant that balances at the Bank of Amsterdam became a pan-European currency and, as noted in an interesting paper from the Atlanta Fed last year, the florin (the unit of account for those balances) played a role “not unlike that of the U.S. dollar today”.


with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

As I am very interested in learning from a) history and b) smart people, I set up a room to discuss the topic on Clubhouse. (I have to say this transformed my view of Clubhouse, because I was blown away by the quality of the discussion that ensued and how much I learned in such a short time. Truly, arguing with smart people is by far and away the fastest way to acquire actual knowledge!)

Cryptocurrencies are more like railway shares in Victorian Britain than tulips in the Dutch Golden Age. Click To Tweet

Aside from tulips, another well-known “bubble”, Britain’s 19th century railway mania, was the subject of some discussion in the room. This particular example is worth studying because I agree with Nouriel Roubini and Preston Byrne’s observation that that the cryptocurrency mania of today “is not unlike the railway mania at the dawn of the industrial revolution in the mid-19th century”. If you want to read more about this, I wrote a detailed article about it a couple of years ago and, in fact, noted the incredible scale of the mania in Financial World magazine a decade back: The first railway service in the world started running between Liverpool and Manchester in 1830 and less than twenty years later the London & North Western railway had become the Apple of its day, the biggest company in the world. This boom in turn led to a colossal crash in 1866, which then led to a revolution in accounting and auditing.

My good friend Maya Zahavi drew the parallel between railway mania driving the introduction of accounting standards that led to new global capital markets in Victorian times (which in turn led to new kinds of regulation and institutions) and that world of defi: The world of financial services, including lending, exchanges, investment and more that are built on shared ledgers and smart contracts. I think she is right. I have long held the view that while cryptocurrencies themselves may or may not have a future as money, the evolution of digital assets that are secured by the underlying networks (“tokens”) points towards new services, markets and institutions that may well lead to a better financial sector.

This view, that digital assets (“tokens”) are where the next generation of financial services will be forged, was reinforced in a new paper published in the Federal Reserve Bank of St. Louis Review. In it, Fabian Shar explores the evolution of markets based on tokens that sit on blockchains of one form or another. He looks at three models for “promise-based” tokens: off-chain collateral, on-chain collateral, and no collateral.

  • Off-chain collateral means that the underlying assets are stored with an escrow service, for example, a commercial bank. There are already several examples of off-chain collateralised stablecoins. The most popular ones are USDT and USDC which both USD-backed* ERC-20 tokens on the Ethereum blockchain.
  • On-chain collateral means that the assets are locked on the blockchain (in a smart contract).
  • Algorithmic tokens that are not backed by collateral at all, but whose value is maintained by algorithmic market interaction. This was, incidentally,  the original meaning of the word “stablecoins” that has now been hijacked by imprecision)

The trading of these tokens, if it were to take place in the existing market infrastructures, would be interesting enough. But to Maya’s point, this is not where we are going. We are heading into the defi era where there is an impending explosion of business models, institutional arrangements and transaction complexity which, when it settles, will leave us in a new financial world. I strongly agree with the view of Jay Clayton (when chairman of the U.S. Securities and Exchange Commission) that “everything will be tokenised” and the obvious corollary to this that everything will be decentralised. It is not the underlying cryptocurrencies that will be the money of the future but the that they support. As the St. Louis Fed’s paper concludes, and as I wrote in Forbes back in January, defi may potentially contribute to a more robust and transparent financial infrastructure.

In the long run (and the lessons from history are clear), I think this will be much more important and lead to much greater structural change (and therefore opportunities) than cryptocurrencies. We can already see the world of tokens entering the mainstream: Dapper Labs (the company behind the famous token game CryptoKitties) is as I write raising $250 million at a $2 billion valuation and Celo, a defi alternative to Facebook’s Diem, has just raised $20 million from (amongst others) noted Silicon Valley investors Andreessen Horowitz.

There are good reasons to welcome these pointers to the emerging paradigm. While defi is now mainly used for speculation between tokens of many varieties, in the longer term it offers the promise of much reduced costs in financial intermediation by both removing middlemen and automating them, it opens up the possibilities for new financial instruments better suited to the new economy (instruments built for bots to trade, not for people to understand). It also, and most importantly (for reasons discussed before), offers a more transparent market with accountability as part of the infrastructure. Don’t be put off by the Wild West of defi as it stands now, begin your scenario planning for defi as it will (inevitably) become.

*Does not constitute financial advice.

[An edited version of this article was first posted at Forbes, 15th February 2021.]