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Rapid Response Team: 0800 559 3500
Switchboard: +44 (0)203 947 1539
Rapid Response Team: 0800 559 3500
Switchboard: +44 (0)203 947 1539

The Popularity of NFTs: Status, Risks, Regulation & the Law

Author: Syedur Rahman  24 January 2022
3 min read

If anyone doubted the appeal of Non-Fungible Token'>NFT’s, they should perhaps take a look at the Bored Ape Yacht Club (BAYC) – a collection of 10,000 individual ‘bored ape’ images that have generated more than $1 billion in sales. They should also bear in mind that crypto transactions last year amounted to $15.8 trillion, with the three highest-priced NFT’s alone going for a total of $108 million.

However, the NFT space continues to be plagued by compromised security in the form of hacking, threats from bad actors and subsequent fraudulent activity. According to Chainalysis, 2021, saw $14 billion in criminal crypto transactions in 2021, up from $7.8 billion in 2020.

To go back to BAYC, a recent hack and theft saw 15 bored ape NFT’s worth $2.28 million taken from a gallery owner through a phishing scam that drained his Ethereum wallet. Fortunately, the gallery owner was able to recover several NFT’s and freeze his apes with the assistance of OpenSea. In response to the hack, OpenSea confirmed that it did not have the power to freeze or delist NFTs that exist on these blockchains; but it could disable the ability to use OpenSea to buy or sell stolen items. However, OpenSea does not have the power to stop the NFT’s simply being transferred to another marketplace and being sold onwards. The risk, therefore, is clear and obvious. 

Exchanges such as Coinbase offer crime insurance on their accounts of up to $250,000 per individual to protect a portion of digital assets from theft and security breaches. This provides some level of comfort. But the policy does not cover losses incurred through unauthorised access to users’ account credentials.

The Status of NFT’s

The exact status of NFT’s has yet to be officially decided. There is still a lack of clarity on whether an NFT can be described as a security in accordance with Financial Conduct Authority guidance or a virtual asset, as described by the Financial Action Task Force (FATF). As a result, a dangerous vacuum exists in terms of official oversight of NFT’s.

The need for clarification regarding NFT’s has been recognised by FATF. Recent FATF guidance says that NFT’s are not to be considered virtual assets based on their general use, and that the evaluation of them should be done on a case-by-case basis. Yet the FATF does believe that NFT’s should be regulated as virtual assets when the use of them conforms to the definition of a virtual asset, adding “some NFT’s that on their face do not appear to constitute as virtual assets may fall under the virtual asset definition if they are to be used for payment of investment purposes in practice.’’ 

This presents those involved with NFT’s with the challenge of recognising which NFT’s meet the FATF functional definition of a virtual asset. A look at the current framework within England and Wales in relation to cryptocurrency-related fraud and asset recovery can be of some use in relation to this. 

In order to rely on civil remedies of asset recovery, it is important to identify where the NFTs are, or - if they have been sold or exchanged for another asset - where the proceeds of sale are. In the case of cryptocurrency and NFT’s, this requires victims to act quickly to prevent assets further dissipating. An asset tracing exercise can be complex, and often sees assets move out of the jurisdiction, requiring quick action, to track, identify and freeze them. Anyone looking to recover their assets will require tracing and recovery specialists to work with various countries’ legal systems and make the correct legal applications immediately. 

Relevant Judgements

Once individuals, their locations, and the location of the assets or proceeds are ascertained, they can utilise the interim reliefs available such as worldwide freezing orders and proprietary injunctions as per Ion Sciences vs Persons Unknown and Others. In this case, both a proprietary injunction and worldwide freezing order were sought to preserve Bitcoin or their traceable proceeds, as well as an ancillary disclosure order to identify the bad actors. 

Additionally, a Bankers Trust Order aimed at cryptocurrency exchanges can be sought to require the exchange to disclose confidential information supporting the proprietary claim, as was decided by the High Court in Fetch.AI Ltd & Anor v Persons Unknown Category A & Ors [2021] EWHC 2254 (Comm). For Norwich Pharmacal relief, the legal principles set out in Mitsui V Nexen Petroleum [2005} EWHC 625 are a useful tool for requiring the third-party exchanges, and those involved in the wrongdoing (even innocently) to disclose information as to the identity of the wrongdoer. Where it is not known in which jurisdiction the bad actors are, AA v Persons Unknown [2019] EWHC 3556 (Comm) among other cases, saw the court find that there was a good reason for alternative service. 

The judgments relating to cryptocurrency have highlighted the court’s increasing recognition of cryptocurrency as a recognisable asset that must be protected, and these will form the basis of tracing and recovering crypto assets such as NFTs – at least until the status of NFT’s is fully clarified.

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Syedur Rahman is known for his in-depth experience of serious fraud, white-collar crime and serious crime cases, as well as his expertise in worldwide asset tracing and recovery, international arbitration, civil recovery, cryptocurrency and high-stakes commercial disputes.

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