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Historically, ownership has been defined simply as staking a claim. We own goods, such as farmland, to have the obligation to use and delegate ownership out of scarcity. However, the broad definition of ownership is strictly self-defined by mental constructs, with no natural or physical change that occurs when a good is converted between being owned and not owned. As a result, enforcement over a good becomes an important and defining characteristic of ownership. Without some way to enforce a claim of ownership, any individual can say he or she owns a good. Enforcement adds much-needed protection to a claim. This can commonly be seen through the borders of nations. Nations can claim ownership of certain borders, but those claims become meaningless without a standing army to enforce and protect them. This logic can be extended to an individual’s ownership of land or currency. As a result, individual ownership falls into the encompassing term of property rights, where centralized institutions create contracts with individuals to protect their property.
Digital property rights have become a prominent subject in policymaking in recent years, giving protection to digital forms of art. However, these regulations frequently fall short of protecting emerging technologies, particularly within the realm of Web3. This can specifically be seen in the case of non-fungible tokens (NFTs). By allowing individuals to verify ownership of each digital product across multiple platforms, as a result, digital ownership has taken on an altogether new meaning. In a digital age, the murkiness of ownership can now be uniquely defined. Even though instances such as NFTs create new values of ownership, the enforcement of these types of property has mostly been left unregulated. This has ultimately led to the development of scams and other unsavory acts that plague the Web3 industry.
Crypto Rugpulls in Web3
Crypto exit scams, colloquially known as “crypto rug pulls,” have become commonplace within the Web3 industry. These types of scams involve bad actors capitalizing on the hype found in the space to promote and bolster the value of their cryptocurrency or token. The bad actors sell off their share of ownership for massive mark-ups and proceed to let the value tank, scamming all of the prior stakeholders in the process. Traditional entertainment tech and media like movies and video games, may deploy a large team on a project and complete it to fruition before marketing the project to the public. Conversely, NFT projects often market first, taking in money from the public, with promises of a roadmap. As a result, it’s common for projects to halt early in the road map, and disband a project after getting the money – hence known as a “rug pull.”
One example of a rug pull project was the Baller Ape Club, a project that led to generating $2.6 million in sales from its community. The project shut down immediately after selling out and disappeared on social media while taking the investors’ money, and the founder reportedly spread the funds across multiple different blockchains to cover the case. In 2021, over $5 billion was generated by NFTs, but no charges were filed by the U.S. Justice Department. With the frequency of rug pulls that happen, the low law enforcement rate fails to deter more scam projects from happening.
Another example of a recent rug pull project is Frosties, which was an ice cream-themed collection of 8,888 NFTs started by two 20-year-olds. Like Baller Ape Club, this project disbanded all of its socials, Discord, and website after selling out, and the founders reportedly were not reachable. Unlike many previous projects that went underground without being charged, the two founders of Frosties were charged by the U.S. Justice Department for wire fraud and money laundering. In the press release of the charge, the evidence highlights how closely the U.S. Department of Justice could use the wallet to be able to trace back where the money was transacted at each stage. Though scams and fraud currently proliferate the NFT ecosystem, the Frostie case proves that the evidence could be used to retroactively catch these cases of fraud with each wallet transaction.
One of the main consequences of these events is that the general population is the most affected by the scam. Their money ultimately just vanishes, and no one is held accountable for it. As a result, crypto exit scams have been able to delegitimize the Web3 space because of the established track record of distrust between the two groups. In an interview conducted with Liat Shetret, Head of Global Compliance at Elliptic, she underscored these concerns. She remarks, “I think there’s reputational damage to crypto as … there is this perception that crypto is just bad and all the rug pulls and all the fraud schemes and so on, which endlessly perpetuates that narrative.” Another consequence, Shetret believes, pertains to the consumer and investor protection regulatory challenges, which are frequently not satisfied. The community doesn’t have the right safeguards in place to ensure that funds don’t go missing. She believes that the Web3 industry is undergoing a maturation process that is affecting the sector at a time when the limits or regulatory perimeter have not yet been established.
So at the end of the day, what could be a potential solution? Shetret alludes to cooperation between the public and private sectors. She mentions during the interview that central governments should “consult with industry in a private-public forum about what it takes to ensure that investor and consumer protections are in place.” Building on this idea, the community can become involved with its governance by establishing a DAO, or Decentralized Autonomous Organization, that can hand out accreditations to firms going through the ICO process. The accreditation process would be rigorous where the voting members of the DAO would research and vet the legitimacy of the organization and token, then vote on whether or not the firm should receive accreditation. As a set of community codes is established, these actions will help to promote a culture in which peers hold each other to high standards and regain the trust of the general population. The other aspect of this DAO would include writing research reports for the government. This will allow policymakers to have a better understanding of how to make effective policies because the knowledge driving their decisions originates from the Web3 industry.
ABOUT THE WRITERS
Matthew Schultz covers gamification, crypto-compliance, regulation, and start-ups.
Nancy is a fellow and contributor from Carnegie Mellon. She covers internet culture, DAOs and more.
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