Are NFTs the Next ICO Fraud?

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howard brands

Co-Founder of Activision and Co-Founder and CEO of StartEngine

Source: CryptoPunks / Larva Labs

Just when you thought you were safe and the US enforcement agencies had cleaned up the ICO (initial coin offering) space, you’re not. The next step is the NFT craze, and it is no different than what happened before with ICOs. Only this time, the fraud is hiding behind the art and collectibles.

Do you want to buy a virtual work of art for $1.98 million?


Source: CryptoPunks / Larva Labs

You can buy this CryptoPunk 6649 for $1.98M. You will not be the sole owner. Sorry. Instead, you will share this asset with 87 of your friends. This puts this virtual work of art made in ten minutes by a decent artist at $174 million. Not bad for a piece of art that no one will be able to hang on their wall.

What is happening? The NFT market has exploded. People buy unique virtual works of art on the blockchain and then trade them. Sounds familiar? This was the ICO market four years ago.

A group of founders wanted to create a new cryptocurrency or blockchain, they wrote a white paper in a few days, published it on a website, did some marketing, talked to a lot of people in original cities around the world, and voila! !

Once the ICO was launched, they raised $15 million in 59 seconds.

The reason investors jumped on these ICOs is simple. The promoters convinced one or more trading platforms to list this new crypto and allow investors to trade and earn a 5x return just a few days after their investment.

Everything was working so well for everyone until the SEC decided to look into it. Unfortunately, they determined that these cryptocurrency sales were the sale of securities, and none of the companies behind those sales had registered those securities with the SEC. The SEC sued quite a few of them. Hundreds of millions of dollars of restitution later and many convictions and bans from running a public company, the ICO market crashed. Things got very quiet.

Enter the NFT (Non-Fraudulent Technology)

NFTs are taking a similar approach to ICOs, and perhaps an even more creative one. A group of business people find cool artists to create virtual works of art, divide them into many tokens, and then auction the tokens off to investors. Then those investors turn around and sell it in the markets.

These operators are creating unique works of art divided into, say, 100 tokens and convincing investors that if they buy them they will be able to resell them for more money because NFTs like this will never be issued again. Depending on the scarcity of the tokens, people can buy them for $10 or $1 million. What an interesting way to create FOMO (fear of missing out) and trade a secondary market.

So where can you buy one of these “cryptopunks” for $1.98 million? Cryptopunks was created by Larva Labs, which claims to be an experimental project company. On their website, as of August 16, they state that there were 12,002 sales in the last 12 months, and the total value of those sales today is $1.04 billion.

Yes, you read it right. Over a billion dollars of value behind these pixelated images. Mad? Maybe not because people are willing to buy them. The problem, however, is that these friendly and sometimes frightening images are sold to investors who buy securities.

Of course, the pixelated image itself is not a value in any way. It’s just a work of art. But selling works of art in pieces of property is a security. Look masterpieces. They will sell fractional ownership of a painting to many investors, and the offering for each painting is registered with the SEC. I wrote an article earlier about NFT and showed how these are values because they trigger the Howey test (a famous standard to determine if something is a value or not).

The core of the problem is that there are markets to sell and investors expect profits.

It’s about the market

Like other historical crypto markets, a key draw for NFTs is that there is liquidity. People can trade these assets with each other. OpenSea is the marketplace for Cyberpunks.


Source: OpenSea

If you look at the commercial history of Cyberpunk 6649, you will be surprised.


Source: OpenSea

As you can see, the investor “KeyboardMonkeyVault” bought it for 450 Ether and sold it 2 days later for 810. The profit was 360 Ether. At $3,159 a piece, that’s a total of $1,137,240. In two days. Wow!

This is all fine until the SEC and the 50 state administrators realize that these NFTs are securities and that they need to protect investors from fraud. Clearly, no one really knows who KeyboardMonkeyVault is because OpenSea and Larva Labs are not regulated entities. They are not brokers. They are not Alternative Trading Markets. They are not registered with the SEC and supervised by FINRA.

So what are the consequences if the SEC investigates this? Remember what happened to the ICO craze? Not so good for entrepreneurs and operators.

While we wish them the best, I’m not sure things will turn out well. Selling securities without proper licenses is a violation of United States law. Additionally, they could be prosecuted for fraud and all sorts of other violations.

The good news is that SEC Chairman Gary Gensler has publicly announced that they will be looking into this, saying, “I think we now have a crypto market where a lot of tokens may be unregistered securities, with no disclosures and no market oversight.” Don’t say that people weren’t warned when this NFT business came back to reality.

This article is part of the Gaming Metaverse Writing Contest organized by HackerNoon in collaboration with the sandbox.

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