Victims Allegedly Defrauded Of US$1 Million; Second Scam Planned For March
By Rashmi Ramesh • March 26, 2022
Two 20-year-olds have been arrested and charged in Los Angeles, California, on Thursday for conspiring to commit wire fraud and launder money as part of a million-dollar scheme involving non-fungible tokens – or NFTs. Both the charges carry a maximum sentence of 20 years in prison.
In January, Ethan Nguyen and Andre Llacuna allegedly defrauded “hundreds, if not thousands” of victims to the tune of $1 million by putting on sale NFTs advertised as “Frosties,” according to a Department of Justice statement. Nguyen is also known under the aliases of Frostie, Jakefiftyeight, Jobo, Joboethan and Meltfrost, and Llacuna’s alias is heyandre.
The two men “conspired, confederated and agreed together and with each other to commit wire fraud, in violation of Title 18, United States Code, Section 1343” between September 2021 and March 2022, a copy of the DOJ’s complaint shows.
After the victims purchased the NFTs, the defendants allegedly transferred the cryptocurrency payments to “various cryptocurrency wallets under their control,” without providing the advertised benefits of owning the NFTs, the statement says.
The Frosties website promised NFT buyers rewards such as giveaways, early access to a metaverse game and exclusive Mint Passes to upcoming Frosties seasons as part of the transaction, the DOJ statement says.
“In reality, on or about Jan. 9, Nguyen and Llacuna, whose legal identities were disguised to Frosties NFT purchasers, abruptly abandoned the Frosties NFT project within hours after selling out of Frosties NFTs, deactivated the Frosties website, and transferred approximately US$1.1 million in cryptocurrency proceeds from the scheme to various cryptocurrency wallets under their control in multiple transactions designed to obfuscate the original source of funds,” the statement says.
This type of fraud is known as a “rug pull” scheme, in which the creator of an NFT or other digital asset solicits investments from unsuspecting victims, only to abandon the project abruptly and retain the investors’ funds. In 2021, rug pulls accounted for 37 per cent or US$2.8 million worth of cryptocurrency – of all cryptocurrency scam revenue, compared to just 1 per cent in 2020, according to a Chainalysis report.
Second Scam Was in the Works
The defendants were preparing to set up another, similar fraudulent NFT sale – this one dubbed Embers – prior to their arrest in Los Angeles, California on Thursday.
“The Department of Homeland Security New York’s Dark Web and Cryptocurrency Task Force worked closely with our Internal Revenue Service (Criminal Investigation) partners to identify and shut down these fraudsters as they prepared to launch the sale of yet another NFT project that would have likely scammed countless others,” says acting special agent in charge of the New York field office of the Department of Homeland Security, Ricky J. Patel.
Agents from the United States attorney’s office, the Internal Revenue Service – Criminal Investigation, the HSI and the US Postal Inspection Service began the investigation of the case in January, based on complaints from the victims of the scam.
Scam Details
The “first investigator” on this case, chief compliance officer of financial services firm LVL, Michael Fasanello stumbled upon this scam during a casual Reddit browsing session, he tells ISMG.
“A few people in an NFT subreddit claimed that they had been scammed. I took statements from victims on the Reddit NFT subreddit and began comparing them with the path the funds were traveling on the blockchain … to see if these claims were true, or if this was just buyer remorse,” he says.
He soon realized that the NFTs should have been accompanied by other benefits besides just the digital art, but the project founders had abruptly bailed and left the purchasers holding the bag. “I knew we had a potential large-scale fraud case to look at. Hallmarks of potential illicit activity, like peel chains, address hopping and use of mixers like TornadoCash, were evident in the blockchain intelligence, and I knew this was a solid case to hand to the feds,” he says.
A special agent with the Office of Internal Revenue Service – Criminal Investigation, Marco Dias says he reviewed screenshots cataloged on a publicly available internet archival website and spoke to three Frosties NFT purchasers during the course of the investigation.
Dias says that, around December 2021, the scammers began advertising the sale of Frosties on social media platforms Twitter and Discord. Those who were interested in purchasing the NFTs were directed to the Frosties website, he says.
Now, every cryptocurrency transaction – and associated details, such as the date and time of the transaction and the unique cryptocurrency addresses associated with it – is recorded on a public ledger, aka the blockchain. The record, however, does not identify the parties that control the cryptocurrency addresses.
In the case of the Frosties, the transactions were recorded on the Ethereum blockchain. A review of blockchain transactions connected to the Frosties website, where the NFTs were sold, shows that “there were likely hundreds, if not thousands, of victims who purchased one or more Frosties NFTs,” Dias says.
The website advertised each Frostie to cost about 0.04 ETH, which equaled $123 to $136 the time of the Frosties NFT sale. “In total, the Frosties website advertised 8,888 Frosties tokens for sale,” excluding gas fees, he adds. The gas fee is the amount paid for every transaction on the blockchain.
After the victims bought all the advertised NFTs within hours of their listing on Jan. 7 or Jan. 8, the scammers transferred all the proceeds from the sale to a separate cryptocurrency wallet address and deactivated the website.
“Shortly after these events, there were several posts on social media sites, including Discord and Twitter, that there had been a ‘rug pull,’ meaning that the Frosties project creators had ended the NFT project prematurely and taken the purchasers’ money,” Dias says.
In total, approximately 356.56 ETH, then valued at approximately $1.1 million, was transferred from the account to which the victims paid money to the fraud wallet address.
Dias, along with Paul Nugent, an HSI special agent who was also part of the investigation team, did not respond to ISMG’s request for comment.
“This is essentially the first time we have seen charges from DOJ associated with an NFT rug pull,” Ari Redbord, head of legal and government affairs at TRM Labs, tells ISMG.
“While NFTs have extraordinary promise – to hash records, art, real estate holdings to an immutable public ledger – they also allow illicit actors to transfer value at the speed of the internet. Here we saw investigators from across federal law enforcement work together to trace funds, identify individuals and make arrests. These types of cases are important, because we have seen a number of NFT rug pulls over the last year or so, and law enforcement here is sending a message that you will be found and punished,” he says.
NFTs: ‘Ample Opportunity for Fraud’
The popularity of NFTs has skyrocketed in the recent past – not just for legitimate buyers, but also for scammers.
A February report by Chainalysis shows that NFT marketplaces and collections increased from US$106 million in 2020 to US$44.2 billion in 2021. But as the popularity of NFTs grew, so did related crime. The company tracked US$8.6 billion worth of cryptocurrency-based money laundering in 2021, even as the value sent to NFT marketplaces by illicit addresses spiked significantly in the third and fourth quarters of 2021.
Redbord says that the nature of an NFT drop is to create FOMO in the market – the fear of missing out on the next CryptoPunks or Bored Ape. “That creates opportunities for fraudsters who prey on that FOMO to build interest and then ultimately pull the rug and make off with funds,” he says.
Inspector in charge of the New York office of the US Postal Inspection Service, Daniel B. Brubaker says the rise of various cryptocurrencies has “changed the landscape of buying and selling investments, leading to ample opportunities for new fraud schemes.”
Regulators have just started to focus on NFTs. The US Financial Action Task Force recently provided guidance explaining that NFT collectibles may not be virtual assets, but if they can be used for payment or as an investment, they may be treated like cryptocurrency for anti money-laundering compliance purposes, Redbord says.
According to Redbord, “Last month, the Financial Crimes Enforcement Network – or FinCEN, for the first time, weighed in on NFTs in a study on the use of high-end art for money laundering. FinCEN discussed the ability of illicit actors to move NFTs at unprecedented speed and scale, especially when compared to physical art. We are likely going to see a lot more from Treasury on NFTs in the coming months.”
Echoing the need for regulations in this space, Fasanello says that in traditional finance, regulatory obligations with implementing proper controls around AML, sanctions, fraud and threat finance have been instrumental in reducing abuse of the ecosystem.
“In the digital assets space, the rules are largely less formalized, mostly derivatively applied through the actions of the entities versus their inherent nature – take, for example, MSBs. Some crypto services avail themselves of AML program obligations by acting as Money Services Businesses, whereas others do not and therefore are not yet required to operationalize those same requirements under the Bank Secrecy Act,” he says.
While there is investigation and prosecution of the perpetrators, facilitators such as marketplaces need to be admonished for enabling an environment of exploitation, he adds.
