Non-fungible tokens (NFTs) are blockchain tokens linked to digital assets such as art and physical assets such as real estate. They can be bought and sold, and there is a thriving market for in-demand NFTs. As with fine art and other assets with volatile and subjective pricing, NFTs can be used to launder the proceeds of crime.
While anti-money laundering (AML) regulations focused on cryptocurrency and NFT money laundering are in the early stages of development, businesses involved in buying and selling NFTs should be aware of the risks and the AML strategies available to combat them.
What is an NFT?
An NFT is a token stored on a distributed blockchain ledger, often the Ethereum blockchain. NFTs are similar to cryptocurrency tokens but differ in two key aspects: Each NFT is unique—or non-fungible—and includes information connecting it to an asset stored outside the blockchain. NFTs are minted by software running on the blockchain network and sent to a blockchain address. Only those with access to private cryptographic keys associated with that address can send the NFT to a different address.
Perhaps the most famous NFT is “Everydays—The First 5000 Days” by the digital artist Beeple, which was sold for $69 million in 2021. Many of the most popular NFTs are marketed as collectibles, including the Bored Ape Yacht Club, Cryptokitties, and VeeFriends.
It’s worth emphasizing that, unlike the fine art market, an NFT doesn’t give the owner control of a physical asset or even the digital asset it’s linked to—anyone can download a copy of “Everydays.” The NFT market is driven by the desirability of digital tokens, which depends on the popularity of the associated artwork or asset, making prices highly volatile and largely subjective.
The NFT market grew exceptionally quickly in 2021. In September of that year, the combined primary and secondary NFT art market was worth around $880 million, with the secondary market representing 80% of the total value. Today, the NFT market is worth a fraction of the high point. However, NFTs remain an easily traded, largely anonymous digital asset that is attractive to money launderers.
What Is NFT Money Laundering and Wash Trading?
NFTs have several qualities that make them attractive to money launderers, including:
- Pseudonymous trading: NFTs are owned by the possessor of the relevant cryptographic private keys. The keys needn’t be connected to a “real-world” identity.
- Open access: Anyone can carry out transactions on public blockchains without verification (although most transactions pass through centralized marketplaces and exchanges that should comply with KYC regulations).
- Highly mobile: NFT trades are not limited by international borders. They can be sold to anyone, anywhere in the world, without inspection, customs checks or physical transport and storage.
- Subjective pricing: NFTs are worth whatever buyers are willing to pay.
Money laundering aims to legitimize money with illegitimate origins. NFTs can contribute to that process.
One common NFT money laundering technique is a form of wash trading, where an individual buys an NFT they already own using different private keys. A launderer buys a low-priced NFT using one set of cryptographic keys. They or a trusted third party then rebuys it using criminal proceeds with different keys, creating a sale record and demonstrating a legitimate source for their money. They then sell the NFT to an unsuspecting buyer. If the launderer is careful, connecting both sets of keys to the same individual is almost impossible.
For additional information, view our blog on cryptocurrency wash trading.
Regulatory Compliance Risks Arising from NFT Money Laundering
The Department of the Treasury’s Study of the Facilitation of Money Laundering and Terror Finance Through the Trade of Works of Art has warned that, “the ability to transfer some NFTs via the internet without concern for geographic distance and across borders nearly instantaneously makes digital art susceptible to exploitation by those seeking to launder illicit proceeds of crime because the movement of value can be accomplished without incurring potential financial, regulatory, or investigative costs of physical shipment.”
Additionally, the Department of Treasury has stated that NFTs used for investment may meet the Financial Action Task Force’s definition of virtual assets. As a result, companies facilitating NFT trading may be considered virtual asset service providers (VASPs). VASPs fall under Financial Crimes Enforcement Network (FinCEN) money laundering rules, obligating them to implement AML processes.
NFT AML Strategies That Reduce Compliance Risk
A business concerned that it may face regulatory risk from NFT money laundering should implement processes to comply with AML. Financial institutions dealing with this novel form of currency should add NFT management to current compliance risk assessment, applying a risk-based approach to crypto and NFT AML compliance.
This includes implementing processes used to combat the financing of terrorism (CFT), and sanctions regulations, including identity verification, Know Your Customer (KYC) processes, and transaction monitoring.
Alessa provides a wide range of AML compliance solutions for cryptocurrency. We can help your AML team identify money laundering activity with ID verification, KYC processes, real-time transaction monitoring, and AML workflow automation. To learn more, request a demo today.
