How to Tell the Difference Between a Legitimate NFT and a Rug Pull

A lot of people, especially in the security industry, are concerned that NFTs are a scam. And that’s for a good reason in many cases, since many of them are.

In fact, I’d say it’s something like 95%. That’s not a real number, but that’s where I’d put the ratio.

But I’m not trying to convince you that NFTs are scams. Or that they aren’t. What I’m trying to convince you is that 1) both exist, and 2) it’s possible to tell them apart.

What is value?

In order to tell the difference we have to ask ourselves what it means for something to be valuable? Quite simply, things have value if they’re valued. A giant block of platinum is worthless if it has no worth to anyone. And a stick figure drawing on a napkin could be worth life itself to a specific individual.

It’s also possible to create value through marketing. In the 40’s and 50’s, corporate America decided we needed mortgages and diamond rings, so they generated marketing campaigns (like Mad Men) around homeownership and diamonds being a girl’s best friend. The result is that most women still idealize getting a diamond today, and most people still see owning a home as a major milestone.

The value of diamonds was manufactured in a Mad Men-style marketing agency.

These desires were manufactured—on purpose—through marketing—to achieve a specific result, which was to create desire for these objects which corporate America would then sell. They created desire for a thing, and the object of that desire then became valuable.

NFTs can work in the same way, and the same game is being played with them. It’s a combination of making a thing, and then trying to generate hype around it. Just like a mortgage or a diamond ring. The trick is in how much value a thing passively and sustainably has once the hype engine slows down.

For a house in the Bay Area, that value is pretty high. For a diamond, which is part of an artificially-controlled marketplace that requires constant control, the hold is becoming more tenuous.

How NFTs attain value

I’ve already talked elsewhere about how NFTs have a future as digital ownership, and as a basis for social signaling. That’s pretty much a given, but the part that’s guaranteed is “digital ownership”, not the NFT part. NFTs are just an early stab at the concept, and digital ownership validation could be called something completely different later, and probably will.

Art is another asset type where the value is based on hype.

The type of NFTs I’m talking about here, though, are the type we see on OpenSea and other exchanges. And the type that are being used to raise money for crypto-oriented projects. Those are the types with the highest percentages of scams, and the type that are creating skepticism with most people.

A lot of the space revolves around art, which is yet another traditional space where hype is the primary driver of value.

Feces on Canvas could be worth millions if enough rich people are in a room looking at it.

That’s a tentative kind of value because if the hype dies down, so does the value. And it’s the same with NFTs.

The NFT rug-pull

The main scam in the NFT and crypto world right now is called a rug-pull. It’s where a team comes up with an NFT, or a coin, and generates massive interest in it. This draws more and more people, who then buy even more, which reduces supply, and drives the price even higher.

Then, once the price gets high enough, the founders sell everything and walk away. The project crashes and everyone loses their money. Except for the founders. They are instant millionaires.

That’s a rug-pull, but it’s only one way to lose money in the NFT space. The founders could also be duped just like everyone else because they don’t realize the project is worthless either.

Asking the right question

There’s a simple question you should ask if you’re trying to tell whether a crypto or NFT project has a future:

You can ask this for any project.

For NFT art projects you have a simple art play, which we saw above. The idea—just like with diamonds—is that you’re going to convince enough people that this thing is valuable, such that it will become valuable and hopefully increase in value over time.

Ok, sure. That could happen. But your chances go down a lot if it’s not good art, and if you don’t have a lot of luck on your side. If you happen to be one of the first, or you get a celebrity endorsement or something, you might be set. But for all the also-rans there’s no guarantee that the hype-engine around the entire space will be strong enough to carry your mediocre offering.

It’s a risky bet, and it’s vulnerable to both a fizzle (nothing happens whatsoever), or a rug-pull (where the value goes up for a moment and the first-movers immediately exit).

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If it’s not an art play, the question is even easier. Where is the supposed future value coming from? For any given potential project, fill in the following sentence:

This NFT has value because it will allow someone to do ______________ within the company’s ecosystem, which will be independently valuable because of _________________.

What are those blanks?

What does the NFT allow you to do? Is it just a baseball card? Or an art piece? Meaning the value is in trading it in the future at a (hopefully) higher value?

Or will the NFT be more like a VIP pass that gives you special abilities? Like a free lifetime subscription to something, or the ability to jump ahead in line at locations everywhere, etc.

In short, force them to fill in the value statement.

Examples of good and bad NFTs

Here’s an example of a bad NFT/coin pitch that’s highly likely to be either a fizzle or a rug pull:

• What is the core value of the project, seperate from the NFT?It’s just super exciting. It’s the wizz-bang NFT for the wizz-bang network, which has its own wizz-bang coin.Ok, cool, but that doesn’t tell me anything. What do I get when I buy an NFT, and what does that NFT let me get within the ecosystem?So, great question. The NFT provides initial funding for the value creation network we’re building, which is a business that makes things of value for people. It’s a unique approach to creating value.Ok, so I’m not sure what that means, but it sounds like it’s not built yet. So you’re saying you’re going to build a business later, using this money. Is that right?Yes, that’s right, we’re looking to build a much better network than others are building, and current NFT holders will be the first ones in.

This is a Hopium play, as far as I can tell. They haven’t built a business. They can’t even fully articulate the idea of the business. Maybe it’s a scam or maybe it’s just bad business. Either way, you should probably stay away.

Note: This is the pitch for like 80% of NFTs and new crypto coins that I hear about. They’re hype on top of hype.

Remember, hype isn’t the problem. Hype can be nice, and even healthy. But only if it’s pointing to a real thing with real potential. The whole exercise here is to dig to see if there’s something real or not.

Also keep in mind that most bad NFTs/coins are people high on Hopium who don’t realize they don’t have a real business. They think the hype IS the business, and they’re delusional rather than malicious. This can lead to both a Rug Pull or a Fizzle, but it’s not the same as a true Rug Pull where the founders knew from the beginning that it was a scam.

A better NFT/coin

• Ok, so what’s the core value of the project, separate from the NFT?So we’re an investment network for independent artists. We encourage people to patron for small artists that aren’t yet known, and this helps both the artist and the patron.Ok, so what does the NFT do?Yeah, so when you buy an NFT you’re buying the rights to one of the artist’s pieces, you’re also getting a 20% discount on all their future pieces, and you’re getting a 0.5% commission on all that artist’s future earnings. Your NFT also gives you 1,000 Arteest Coins, which can be used to send artists money or buy art within the network.Ok, so the more artists that join the more value the NFTs and the coins have. But won’t this be bad for the artist if too many people buy their NFTs? Won’t they end up not earning that much of what they pull in?There is a maximum to the percentage of funding that can come out of an artist’s earnings, and the earlier supporters get a bigger piece. But by the time the maximum is hit, the artist will be making a healthy living already, which is the entire point of the project!

This is something I’d buy into. It doesn’t mean it’ll work. It doesn’t mean it’s a guarantee. But at least they can articulate the purpose of the project independent of the NFT/coin.

In other words, if the project doesn’t make sense by itself, it also doesn’t make sense as an NFT or as something-something-crypto.

Summary

1. The NFT/Coin space is full of scams and Hopium projects, but there are also some interesting things happening.

2. To determine which is which, ask what the value of the project is—independent of the NFT/Coin.

3. If you can’t get a direct answer, the project is likely either a scam or Hopium, i.e., a scam where the founder is being scammed by themself as well.

4. Hard-avoid any project that can’t articulate its purpose without talking about NFTs or crypto. NFTs and crypto should be seen as new and interesting ways of doing a real business, not a way to make money without providing value.

5. If the project doesn’t make sense by itself, it also doesn’t make sense as an NFT or as something-something-crypto.