On the heels of President Biden’s Executive Order on Ensuring Responsible Development of Digital Assets, the Department of Justice brought charges this month in the Southern District of New York against two individuals, both 20 years old, alleging conspiracy to commit wire fraud and conspiracy to commit money laundering in connection with an NFT “rug pull.” As noted in the criminal complaint, a “rug pull” refers to a situation where a creator offers a collection of NFTs for sale with a promise of future benefits (or "utility") but, after the NFTs sell out, the creator abandons the project and vanishes with the proceeds.
According to the complaint, in January 2022, Ethan Nguyen and Andre Llacuna issued a collection of 8,888 NFTs called “Frosties,” promising their holders benefits in addition to the digital art, including a “metaverse game,” free giveaways, and other exclusive opportunities. After generating over $1 million in cryptocurrency, the duo shut down the Frosties website and Discord server and transferred all sale proceeds to various digital wallets. Now, they each face up to 40 years in prison.
Five Key Takeaways
- This is the first government-led enforcement action against NFT creators, making clear that regulators are paying close attention to the NFT space. While there is no law specifically regulating NFTs, law enforcement can bring criminal actions against malicious NFT issuers based on fraud and other laws that existed long before blockchain technology.
- Investigators successfully identified and gathered compelling evidence against the defendants within a matter of months. The feds demonstrated that they have the resources and ability to unwind complex transactions, follow the money, and unmask “anonymous” perpetrators.
- Decentralized protocols for private transactions like Tornado Cash can muddy the waters for investigators, but connecting a digital wallet to crypto-exchanges, other "off-ramps," or platforms that may collect personal information (e.g., internet service providers, ENS domains, Discord servers, social media accounts) may allow investigators to identify and arrest suspected culprits.
- Many in the NFT space are concerned that the Securities and Exchange Commission will classify NFTs as securities. This enforcement action highlights an additional risk: whether or not the SEC takes the position that NFTs are securities, issuers can still be charged with fraud if they make promises they don't intend to keep.
- For these reasons, NFT project teams must be very careful when making public statements about their projects, especially when sharing roadmaps or promising or suggesting future utility.
Whether or not the SEC takes the position that NFTs are securities, issuers can still be charged with fraud if they make promises they don't intend to keep.