Are fraudsters (soul)bound to fail? An overview of soulbound tokens and their use in fighting fraud

Posted: 04/04/2024

A recent judgment of the High Court of Singapore has authorised the tokenisation of a worldwide freezing order as a soulbound token (SBT), to be attached to private (cold) wallets associated with fraud via a ‘souldrop’ (largely equivalent to an NFT-airdrop).[1] 

The SBT, which permanently attaches to the cold wallet, not only serves the court documents, but acts as a permanent warning to counterparties and exchanges that the wallet has been used in fraud.

This article examines the background to SBTs, and how they can be used to combat fraud and assist with asset recovery.

What are SBTs?

SBTs are publicly visible, non-transferrable, and non-fungible digital tokens stored on the blockchain. The wallets which hold the tokens are referred to as the ‘souls’, and the tokens in them, the SBTs. Unlike NFTs, which can be bought, sold, and traded, or remain editable by the current owner, SBTs are immutable, and once assigned to a wallet address cannot be transferred or owned by another wallet.  

SBTs therefore have greater efficacy in certifying achievements and information associated with a particular individual or entity, because they cannot be transferred to someone else. This can also make them more appropriate for commercial uses than NFTs, such as tickets for music or sporting events, as they cannot be resold on the secondary ticketing market. In this scenario, the stadium could be the ‘soul’ that issues the SBTs to the fans.

History of SBTs

The idea for SBTs came from the video game World of Warcraft, where some items are described as ‘soulbound’ as they cannot be sold or traded. This idea was taken forward in a white paper in May 2022 co-authored by Vitalik Buterin, the founder of Ethereum, economist Eric Glen Weyl and lawyer, Puja Ohlhaver. The authors were motivated by a desire to change the direction of Web3 digital assets from hyper-financialisation and transferability to one in which social relations and trust are enabled and rewarded.

In particular, the authors noted that decentralisation and hyper-transferability stand in conflict with many core economic activities built on trust, goodwill and human relationships; the prime example being direct lending. Direct lending, especially uncollateralised lending, is premised on creditworthiness, which has human factors at its core.

NFTs are limited in their use for direct lending because they are transferable. In addition, the traditional credit world relies on centralised credit scores which are limited by a lack of data and biases.

SBTs aim to improve upon both traditional finance (including Web2 finance) and Web3 decentralised finance (defi), to enable more efficient markets and perpetuate decentralised relationships, facilitating ‘pluralism’. They will achieve this by increasing the ‘uniqueness’ of individuals and networks in the Web3 environment and creating diverse decentralised communities of ‘souls’ that could, in theory, protect minority groups and/or indigenous cultures in Web3.

These are certainly lofty aspirations, but the underlying technology has already found various use cases, particularly in relation to fighting fraud, including the recent first known use of an SBT in legal proceedings in Singapore. SBTs will help overcome the dependency on Web2 by creating an identity and reputation in Web3, differing from NFTs, which provide proof of ownership.

So, are SBTs a promising blockchain innovation that will revolutionise how we prove identity, track credentials and, fundamentally, earn trust in a decentralised world where fraudsters are posing as legitimate businesses?

SBTs as a means of fighting fraud

SBTs, in their initial ‘primitive’ form, are publicly visible, non-transferable tokens placed on a blockchain wallet. While this is just the first stage envisaged in the white paper, it is this non-transferability that has already been promoted as a tool to fight fraud. For instance, SBTs, being linked to the real identities of the creators/operators, and which may contain ownership records stored on the blockchain, could make it harder to obscure or fake identities and easier to trace stolen assets. 

Below are some of the examples of how SBTs can be used to prevent fraudulent activity or prevent abuse.

Sybil attacks
SBTs would potentially prevent the creation of fake identities, which can be used for larger scams such as the ‘Sybil attack’, like the one on the Starknet Airdrop where an attacker utilised 1,361 wallets to claim the tokens being distributed by Starknet at an airdrop event.   

Likewise, SBTs can be used to protect distributed autonomous organisations (DAOs) which are particularly vulnerable to sybil attacks, as their non-transferrable nature means that an individual cannot buy tokens to gain the necessary voting rights for a Sybil attack. SBTs may be the catalyst to allow the growth and adoption of DAOs.

Proof of KYC credentials
Binance uses SBTs as credentials of those Binance users that have passed KYC. These Binance Account Bound tokens (BABs) are non-transferable but are revocable by the issuer (Binance). BABs aim to tackle identify verification issues in Web3 as they digitally verify that the Biance wallet holder has passed the KYC checks. BABs are also the first SBT to be issued on the BNB Chain.

Preventing a fake curriculum vitae (CV)
SBTs could be used to prevent fake educational achievements and work experience being provided to potential employers. For instance, an educational institution such as a university could be the ‘soul’, and issue SBTs in respect of the degree that was obtained, which enables an employer to easily verify the attendance of the individual at the university and the educational achievements obtained. SBTs could also be used to verify the applicant’s previous work history and other achievements, so over time they would build up an identity and reputation in Web3.  However, this does raises privacy concerns.  Solutions to these concerns are explored in the white paper.

Serving court proceedings and freezing crypto assets on a private wallet
Most intriguingly for those involved in asset recovery and crypto-fraud, SBTs can be placed onto an alleged fraudster’s wallet, including their cold wallet, to serve court documents and, given the public nature of SBTs, act as a warning to anyone dealing with the wallet that it is associated with fraud. 

The SBT could be minted so that it stays permanently on the wallet, or revocable by the issuer so that if the freezing order is not extended at the return date or the case is ultimately unsuccessful, the SBT can be revoked or alternatively burned. Service by SBT of a freezing order has recently been ordered for the first time by the Singapore High Court.

Injunctive use cases and the Singapore High Court

In 2023, a London-based financial investigation firm, Intelligent Sanctuary (iSanctuary), was instructed by a businessman who had been defrauded of over $3 million in crypto-assets. As a result of the swift on-chain investigation, the stolen crypto-assets were traced to several cold wallets, as well as wallets on centralised crypto exchanges (CEXs). The CEXs were immediately put on notice of the fraud to prevent dissipation while a freezing order could be obtained.

The evidence obtained from the on-chain and off-chain investigations was submitted to the Singapore High Court, which granted a worldwide freezing order and approved service of the order by NFT. Based on the specific legal requirements for the NFT, the order was tokenised as an SBT by Mintology, an NFT-minting provider, and served on the cold wallets.

Although the SBT does not prevent any transactions, it will permanently remain on the cold wallets and warn counterparties and CEXs that they are associated with fraud, and dealing with them may breach a court order.

In this way, the SBT can act as a ‘wrapper’ on the wallet that inhibits its continued use for fraud. This has been described as a ‘mark of shame’. While previously it was only practicably possible to freeze wallets on a CEX, SBTs go some way to effectively freezing cold wallets as other parties will be less inclined to deal with or receive crypto-assets from a wallet with this marker on it.

iSanctuary is now able to track the cold wallets to ensure that any outgoing transactions are traced, so that if they are transferred to a CEX, it can be placed on notice of the freezing order.

While there have been previous examples in the UK and elsewhere of service of court documents being effected by NFT, this is believed to be the first example of SBTs being used for service.

Risks and issues to consider in relation to SBTs

There are potential risks created by SBTs, and also issues to consider should one decide to use an SBT to fight fraud, or to create credentials and a reputation in Web3.

Courts must be satisfied that the technology works and understand the implications of the characteristics of the SBT that is being proposed for the service of court documents. Ordinarily, an SBT would permanently remain on the wallet of the recipient, signifying to the world that the holder may be a fraudster. But what if the accusations regarding the alleged fraud prove incorrect?  

For instance, on the return date of the worldwide freezing order application, the defendant may be successful in discharging the order and unfreezing the wallet, or they may ultimately be successful in defending the claim. In this scenario, the defendant may suffer loss, such as loss of opportunity to trade with customers who will be deterred by the risk of fraud. This may lead to a larger claim under the cross undertaking in damages if there is a permanent marker on the wallet.

However, the white paper envisages SBTs that are revocable by the issuer or that can be burned and reissued. This is the position that has been adopted with BABs, as they have been minted as revocable tokens. Accordingly, minting revocable SBTs would allay many of the risks with this technology.

The white paper also envisages SBTs that mature. These SBTs ‘first gestate as revocable, transferable tokens, before growing into non-transferability’. This would potentially enable the court to approve a revocable SBT as an interim remedy, at the same time as a freezing injunction, that matures into a non-revocable token when the final judgment has been given.   However, even though a permanent record may be on these particular cold wallets, it does not prevent the fraudster from using other wallets for future transactions in relation to the fraud.

Also, the SBT served on the alleged fraudster’s wallet may contain certain personal data of the alleged fraudster, which could interfere with the right to privacy. The victims too may wish to have their personal data removed after they have successfully recovered their stolen assets.

Relatedly, a nefarious actor may maliciously mint SBTs to mark an innocent wallet, either to suggest it has been used for fraudulent purposes or, if the wallet contains an individual’s SBTs proving their identity and experience, to seek to damage their reputation.

Finally, if you have been using SBTs to build your reputation in Web3 by showing your experience and achievements, what if you lose your seed phrase or your wallet is hacked so that you lose your achievements on your wallet, or the hacker takes actions using your identity? Alternatively, if your wallet is compromised but you still have access, although you can move assets to another one, the SBTs would remain attached to the compromised wallet. This may be resolved by issuing SBTs that can be burned and reissued if such a scenario happens.  Accordingly, it is important to consider when minting the SBT what it will be used for and the characteristic it will need, such as whether it is revocable, or if it can be burned and re-issued.

Conclusion

SBTs are still in their infancy but they have many potential use cases and may be an option that will prevent fraudsters continuing to operate once one victim has come forward. This may have a positive long-term impact, reducing the attractiveness of crypto-frauds. 

SBTs will not stop fraudsters using other wallets for future transactions in relation to the fraud but may make it potentially difficult to deal with the crypto assets that remain in the fraudster’s cold wallet. It remains to be seen whether the English courts will follow Singapore’s lead in using SBTs to combat frauds, and how soulbound technology will continue to develop.

In the future, SBTs may prove important in creating an identity and reputation in Web3, and in creating a decentralised society (DeSoc) as envisaged by the white paper.

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