Decrypting Deception in the NFT Market

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Scholars argue for regulatory intervention to protect consumers from NFT minting companies’ deceptive practices.

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What is the monetary value of an animated cat flying over a rainbow?

About $580,000—at least that is according to the price this digital artwork sold for at an auction held in 2021.

In recent years, the market for digital artwork—often sold as non-fungible tokens (NFTs)—has exploded. But two law professors argue that the digital platforms selling NFTs are misleading consumers about what ownership of these tokens entails.

In a recent article, Juliet M. Moringiello of Widener University Commonwealth Law School and Christopher K. Odinet of the University of Iowa College of Law criticize NFT minting companies’ deceptive advertising and argue in favor of regulatory intervention to protect consumers in the rapidly growing NFT market.

NFTs and other digital tokens are created through minting, which is the process of creating a data entry on the blockchain to represent an asset. Minting platforms then sell the NFTs in an online auction, in which consumers can pay cryptocurrency for a token that purportedly represents ownership of an asset, such as digital artwork, Moringiello and Odinet explain.

But Moringiello and Odinet note that owning an NFT does not mean much in the eyes of property law. As they underscore, current property and commercial law does not allow an NFT to confer any property right to its underlying asset.

When advertising NFTs, however, minting platforms often conflate the tokens with their underlying assets, Moringiello and Odinet explain. For example, Mintable, one of the largest minting platforms, has posted on a public blog that consumers can establish “ownership of an item external to the token.” Another prominent minting platform, Makersplace, has stated on its website that the “token is what provides proof of ownership and authenticity of your creation.”

Moringiello and Odinet argue that such statements have led consumers—and even sophisticated investors—into believing that their NFTs are worth much more than what the law recognizes.

They reason that it is illogical that consumers would spend millions of dollars on NFTs if they knew they were only entitled to ownership of data entries and not the rights to the assets they represent. Some platforms may include disclaimers in their terms of service, but empirical evidence has shown that consumers rarely read the fine print, Moringiello and Odinet note.

Furthermore, Moringiello and Odinet highlight that the average consumer is simply not well-versed in property law.

Misled consumers will inevitably encounter conflicts over NFT transactions, Moringiello and Odinet argue. They give one potential example of a problematic NFT transaction for tangible property—the owner of a sculpture could create an NFT to represent the artwork, sell the NFT to one buyer, but then sell and deliver the sculpture to a second buyer.

In such situations, the NFT buyers could both claim that they own the sculptures or other underlying objects, but the second buyer would in reality be the rightful owner of those objects under property law. Moringiello and Odinet argue that regulatory efforts to police the NFT market are warranted to protect consumers in these transactions.

Moringiello and Odinet acknowledge the opposing argument that consumer problems with NFT transactions should be dealt with through private litigation. But Moringiello and Odinet contend that private litigation is often not available to consumers because of mandatory arbitration and class action clauses embedded in minting companies’ terms of service.

Moringiello and Odinet explain that arbitration presents a “procedural barrier to consumer litigation” because of empirically proven “repeat-player bias” that favors larger companies over plaintiffs, since companies often appear repeatedly before the same arbitrators. In addition, consumers would only be encouraged to bring a claim if they could join with other plaintiffs in a class action. Moringiello and Odinet explain that, with the average price of an NFT at only about $5,800 in 2021, a successful claim would result in damages that would still be significantly less than standard litigation costs.

Such deception, in conjunction with these mandatory arbitration clauses, necessitates intervention by the Federal Trade Commission (FTC), Moringiello and Odinet argue. They contend that the FTC can help protect consumers if they employ their authority to make enforcement threats under the FTC Act. Under the FTC Act, a deceptive practice consists of a “representation, omission or practice that is likely to mislead a consumer acting reasonably in the circumstances.” Moringiello and Odinet argue that minting platforms too often engage in the kind of deceptive practices that the FTC aims to combat.

They propose that the FTC can tackle these platforms’ tactics by issuing “enforcement and compliance bulletins” to inform minting companies of their illegal marketing practices. In addition, they suggest that state attorneys general should do the same.

State attorneys general also retain the authority to issue enforcement bulletins against private companies if they deceive consumers. State attorneys general also have a special role in protecting consumers because of their “on-the-ground view of local markets,” as Moringiello and Odinet put it.

With all the “hype” that NFTs have garnered, Moringiello and Odinet conclude that regulators need to step in to protect consumers in this booming market.