What the NFT Revolution Means for “Friendly Fraud”
They have been used to trade everything from iconic football goals to priceless royal heirlooms. Non-fungible tokens (NFTs) are no longer a niche gimmick coveted by crypto experts and trend chasers – they are a rapidly growing market worth tens of billions of dollars.
An NFT’s value lies in its ability to prove ownership of something intangible, such as a digitized work of art or, indeed, an exciting moment from a sports match that took place half a century ago. This value makes them an increasingly traded commodity, with up to 50,000 bought and sold each week. But they are also an attractive target for cybercriminals.
While there have been some dramatic digital smash-and-grabs in recent months, high-profile hacks aren’t the only concern for NFT players. We are noticing more and more cases of illegitimate chargebacks, sometimes referred to as “friendly fraud”, as tokenized assets become increasingly mainstream.
Dealing with this is not always easy, partly because NFTs are still a new trend in the payments space. But with the right knowledge and tools, businesses can take steps to stay safe as they explore this exciting new frontier of digital commerce.
How to buy an NFT
To understand the potential threat posed by NFT-related friendly fraud, you must first understand how tokens are purchased.
Marketplaces like OpenSea, Rarible and Binance are where the majority of NFT trades take place, either in eBay-like auctions or at a fixed price. Once the sale is complete, the buyer makes an entry on the blockchain – a secure decentralized electronic ledger – and transfers funds to the seller, while the seller responds in kind to transfer ownership of the token.
Blockchain-based transactions are permanent and cannot be reversed by any of the parties – not even by a central authority, such as a bank. In other words, if a deal goes bad, the buyer has little recourse.
Often the currency used for NFT trades is not dollars, euros, yuan or any form of regular fiat money, but rather cryptocurrencies such as Ethereum. In order to complete a purchase with these digital coins, the buyer must hold them in a crypto wallet – and therein lies the problem.
When buying cryptocurrency to store in a wallet, most marketplaces accept conventional credit and debit cards. This means that while the final NFT transaction is not subject to third-party reversals such as chargebacks, the purchase of the cryptocurrency required to pay for it is.
Mixes old and new
All of this means that while NFTs and crypto are generally not subject to chargebacks and friendly scams, they still involve traditional payment methods. It sets the stage for a confusing mix of old practice and new technology – confusion that can be exploited in the form of friendly fraud.
For example, imagine a buyer finds a piece of digital art they think is a good investment, then uses their credit card to buy $1,000 worth of Ethereum on a crypto marketplace to complete the trade.
So far, so good – but what if the NFT’s value then plummets, as can often happen in the volatile crypto world? Desperate to recoup their losses, the buyer may be tempted to file a chargeback claim, perhaps claiming their card was stolen prior to the cryptocurrency purchase.
When dealing with such transaction disputes, the card issuer will often side with the buyer instead of the crypto exchange. While the financial sector is digitizing rapidly, crypto transactions remain something of a blind spot for traditional banks. Marketplaces may believe they have gathered enough evidence to successfully fight a fraudulent claim, but if there is a fundamental knowledge gap at the cardholder’s issuing bank, there is little that can be done.
This leaves the crypto exchange with a bill to pay, while the customer gets their money back and retains ownership of the original NFT, which is effectively locked in a digital wallet inaccessible to the NFT market.
Meeting the challenge
With crypto volatility only increasing, and NFTs continuing to grow in popularity, the threat of fraud will only increase for merchants and marketplaces. To meet this challenge, stock exchanges and other market participants must take direct action to reduce chargeback risk.
Some marketplaces are up front, fighting chargebacks by limiting how quickly users can withdraw after creating an account. NBA Top Shot, for example, only gives withdrawal access to traders who have been on the platform for several weeks, eliminating those who want to make a quick NFT purchase and then submit a chargeback claim.
This is a solid policy, but it is not foolproof. Exchanges should take additional steps to protect themselves, such as implementing a strict customer verification system. By collecting a user’s information when an account is created, marketplaces can position themselves to more effectively fight subsequent fraudulent transaction disputes.
Finally, exchanges and other NFT players should ensure that they have an effective mitigation strategy in place to quickly collect and submit evidence in the event that a chargeback dispute is initiated. Fast-growing businesses like crypto and NFT operators are unlikely to have well-established internal infrastructure, but with chargeback volumes skyrocketing, it’s important to find a solution that can help you meet card issuers’ demands and win more disputes.
A growing concern
Chargebacks are a growing concern for businesses of all kinds, but the crypto and NFT space is particularly vulnerable precisely because it is growing so quickly. Many cybercriminals are looking for opportunities in this poorly regulated sector; many legitimate customers are confused and overextend themselves; and many businesses lack the resources and tools to protect themselves.
Building effective chargeback mitigation capabilities may not sound like a key priority for blockchain innovators. But the reality is that whether your clients are trading NFTs or speculating in crypto, your ability to manage chargebacks can determine your company’s success or failure in this exciting but high-risk market sector.
