Money Laundering Via Non-Fungible Tokens

Nyan Cat. Meow.

Some call it God. Others call it Bitcoin.Cryptocurrency has replaced religion. There will be no turning back in a few years. Actually there’s no turning back now. Not when people are selling virtual land for millions or Nyan Cat for half-a-mil.

In 2021, non-fungible tokens (NFTs) firmly established themselves as a major trend in the digital and traditional art markets. This was proven back in March, when an NFT sold at auction house Christie’s for $69 million.

Wash trading may be undertaken for several reasons by a trader or company. For instance, the goal can be to promote buying to raise prices or sell to lower prices. In essence, a trader is looking for a tax refund when they carry out a wash sell to lock in a capital loss before repurchasing

Wash trading may be undertaken for several reasons by a trader or company. For instance, the goal can be to promote buying to raise prices or sell to lower prices. In essence, a trader is looking for a tax refund when they carry out a wash sell to lock in a before repurchasing the asset at a lower cost basis.

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NFT popularity skyrocketed in 2021. In our NFT market report, we found that at least $44.2 billion worth of cryptocurrency was sent to ERC-721 and ERC-1155 contracts — the two types of Ethereum smart contracts associated with NFT marketplaces and collections — up from just $106 million in 2020. Evidently, interest in Bored Apes and CryptoPunks is growing.

However, as with any new technology, NFTs offer the potential for abuse. So as our industry considers how to monetize digital art, we should also consider how to make sure that these systems are safe, secure, and have anti-money laundering (AML) mechanisms built-in.

In this article, we look at two forms of illicit activity we’ve observed with NFTs:

Let’s dive in.

Main Image Credit A fake NFT which was sold on Banksy’s website in March 2021. Courtesy of mundissima / Alamy Stock Photo

Non-fungible tokens are the latest craze in the digital and traditional art markets – can we mitigate the money laundering risks?

In 2021, non-fungible tokens (NFTs) have seen their popularity skyrocket. An NFT is a unique digital token which is used to represent an asset, usually digital artwork, a piece of music or an item in a computer game. The NFT can be held by its owner, traded, and sold for cryptocurrency or even real-world fiat currency, as occurred when the world’s most expensive NFT artwork was sold for $69 million in March 2021.

NFTs, especially for digital art, have come into existence for a number of reasons. First, they provide an unchangeable record of ownership for any item represented in a digital format. This concept is important because as more of the world moves online, individuals will increasingly want to ‘own’ assets in their digital environment. If desired, the owner of the NFT can also trace previous transactions to determine the origin of the item and prove authenticity. Second, NFTs provide their creators with the ability to earn royalties long after the original sale of the asset.

Both of these attributes make NFTs especially attractive to digital artists who want to prove the authenticity of their work and who in the physical world would only receive payment for the initial sale of their work. While these attributes may encourage more artists to move online, they might also encourage criminals and money launderers who abuse the traditional art market to do the same.

The market for nonfungible tokens, or NFTs, exploded last year.

But with the hype, scammers saw opportunity.

Chainalysis found «small but visible» money laundering activity in NFTs, according to its new report. In the third quarter of 2021, funds sent to NFT marketplaces by illicit addresses «jumped significantly,» Chainalysis wrote, surpassing $1 million worth of cryptocurrency. In the fourth quarter, that amount hit just below $1.4 million.

To calculate its findings, Chainalysis tracked illicit addresses, or those associated with criminals like scammers, to see whether cybercriminals were using illegal funds to buy NFTs.

Chainalysis declined to disclose which specific NFT platforms it analyzed, but said that its findings only include NFTs bought with ether (ETH) and wrapped ether (WETH), not fiat.

Though the amount of potential NFT-based money laundering in 2021 is a «drop in the bucket» in comparison to cryptocurrency-based money laundering overall, Chainalysis said, it’s worth pointing out.

«Money laundering, and in particular transfers from sanctioned cryptocurrency businesses, represents a large risk to building trust in NFTs, and should be monitored more closely by marketplaces, regulators and law enforcement,» the firm wrote.

Investors should consider picking NFT marketplaces that have protections in place for money laundering and other fraudulent activity, says Kim Grauer, director of research at Chainalysis. Choosing reputable marketplaces could help strengthen the NFT market overall.

«NFT platforms should consider rules against wash trading on their platforms to build more trust in this asset class,» she adds.

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Don’t miss: Over $10 billion was stolen in DeFi-related theft this year. Here’s how to protect yourself

Updated August 29, 2022 / Original August 28, 2022

Nonfungible tokens, or NFTs—digital assets like Bored Ape Yacht Club avatars—are struggling to find buyers in the crypto slump, but crooks still love them, a new analysis shows.

More than $8 million in illicit funds have been laundered through NFT-based platforms since 2017, according to a review of the numbers by Elliptic, a crypto-risk management firm.

Another $328.6 million has come from asset obfuscation tools by virtual currency mixers that make anonymous transactions easier by mudding up their origin, destination, and parties. Together, the money laundered on NFT platforms and funds that made their way there from asset obfuscation services represent almost 1% of all NFT transactions.In just a year, from July 2021 through July 2022, more than $100 million in NFTs were reported stolen through scams—and each scam netted the scammers on average $300,000, according to Elliptic.This July, the number of stolen NFTs hit more than 4,600—a record high—despite the crypto bear market, according to Elliptic’s team. “However, actual numbers are likely to be higher, as thefts are not always publicly reported,” the team wrote.A chunk of all stolen tokens—23%—can be tied to security failures on social media platforms, especially the messaging platform Discord.The bad PR may have taken its toll, but probably not as much as a slump across the digital asset space that has seen the market cap of crypto decline to $1 trillion from nearly $3 trillion in November. Works of digital art that once changed hands for huge sums—sometimes millions of dollars—are now a bit less shiny, and Bored Ape Yacht Club and CryptoPunks don’t command as much attention as they once did. Today, daily NFT sales hover around 40,000 NFTs—a fraction of the more than 209,000 a day last August.The crash also puts some of the most famous and valuable NFTs at risk of being liquidated, according to John Todaro, an analyst at investment bank Needham. Last year’s bull run in Bitcoin and other tokens was fueled by leverage, where traders posted collateral to borrow money for supersize trades—and a significant number of NFTs were posted as collateral, Todaro explained in a note.If the required amount of collateral, expressed as the market value of an NFT, falls below the required level, investors could have their digital assets liquidated and lose their Bored Apes and CryptoPunks.Some 3% of all Bored Apes Yacht Club NFTs are hosted on a single lending platform, according to Needham. That might wake up the apes.

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In this respect, a practice known as wash trading has been identified in the NFT market, consisting of transactions in which the seller and purchaser of NFTs is the same person in successive transactions. The gain lies in increasing (or inflating) virtual asset values, through this repetitive speculative behavior, which catches the attention of potential buyers who end up buying an asset at a very high price with enrichment for the agent who gave rise to that wash trading. According to the data provided in the Chainalysis report, a group of 110 NFT owners achieved US$ 8.9 million in profits from wash trading.

This practice shows, as the FATF highlighted in a targeted update on implementation of the FATF standards on virtual assets and virtual asset service providers, that more exhaustive and customized rules are needed for this growing market, based on the risks it presents. Accordingly, because NFTs appear to fall outside the scope of application of the proposal for a MiCA Regulation which is intended to apply to crypto-assets, and they do not fall either among the financial instruments regulated by the MiFID II rules, the option is being considered of treating them as assets akin to works of art, which would open the door to effective regulation by broadening the scope of institutions subject to AML/CTF obligations, for the purpose of including these platforms for NFT transactions.

Mike Winkelmann is an American digital artist and animator. Known professionally as ‘Beeple,’ he has earned millions of dollars selling digital works of art, and is enormously popular and successful. In March 2021, Christie’s auction house sold a digital collage of his images called Everydays: the First 5000 Days as an NFT or non-fungible token for over $69 million – the world’s most expensive NFT sale.

Scams and stories like this involving cryptoassets such as digital currency and artworks are becoming more and more common. According to Atlas VPN, almost $1.3 billion worth of cryptocurrency was stolen in the first three months of 2022 alone.

“While the majority of cryptocurrency owners and those purchasing NFTs are doing so for righteous reasons, criminals look for any way to exploit new technologies” — The Joint Chiefs of Global Tax Enforcement

What’s being done to combat NFT crime?

In April 2022, a consortium of governing bodies (including the United States’ IRS, the UK’s HMRC, and agencies from Australia, Canada, and the Netherlands) issued a warning to banks, legal authorities and private collectors of the growing money laundering and fraud risks surrounding NFTs.

The consortium is called The Joint Chiefs of Global Tax Enforcement, or J5.

J5’s Cyber Group arm is currently lead by Special Agent Oleg Pobereyko, who warned that “this space is changing so fast, and technologies and products have the ability to become the ‘next big thing’ without any due diligence or regulation on the part of the creator of the product,” adding that he hoped the J5 advice “would help keep people safe while law enforcement catches up to these particular concerns.”

The money laundering risks involved with NFTs

In terms of money laundering, just how risky are NFTs?

An NFT can be held by the original artist or sold for cryptocurrency, and even sold for real-world fiat currency, as with Beeple’s Everydays: the First 5000 Days.

“While the majority of cryptocurrency owners and those purchasing NFTs are doing so for righteous reasons, criminals look for any way to exploit new technologies,” the report explains. “Cryptocurrencies and NFTs are not immune.”

The report highlighted several red flags that could indicate suspicious transactions in NFTs, including:

The top 3 crimes involving NFTs

Karyn Kenny is a legal adviser for the US Department of Justice (DOJ), and an expert on crime in digital currencies and NFTs.

Speaking to Napier, she said that NFTs are vulnerable to money laundering just as real-world paintings, sculptures, and other artworks are, and highlighted three key crimes involving NFTs:

Rug pulls

“Rug pulls might be where a bad actor will set up an NFT, telling investors they’re going to use it as a cryptocurrency,” explained Kenny. “They say, ‘get in early and see your profits rise’. But they have no intentions whatsoever of setting up a platform.”

Wash trading

When an investor or trader buys and sells the same NFT multiple times within a short period, they are able to then deceive buyers about its price or liquidity. “The same person is on both sides of the transaction of the NFT,» Kenny explained. Illegal wash trading is already common in traditional commodity trading markets.

Kenny said it’s even possible to set up NFT sales through smart contracts that buy and sell to the same owner. “They set up a transaction that provides a fee every time that NFT is sold to somebody else,” she added. “So essentially it’s a false sale.”

Insider dealing

OpenSea, a popular NFT marketplace, recently admitted that one of its employees profited through this method, which essentially sees individuals using insider, non-public information for financial gain. Insider dealing is illegal in most regulated markets, and has now been banned by OpenSea, but the NFT market itself doesn’t have such rules.

How to prevent NFT crime

While most experts believe that money laundering in NFTs is not yet rife like it is in other areas of financial crime, they agree it is a growing problem. But what can NFT buyers and the authorities do to mitigate it?

Self-education

She also cautioned that NFTs are attractive to investors because they are such a novelty. “They are considered cool – a badge of contemporary awareness. Buy an NFT and you’re hip, you’re happening.”

Private-public information sharing

She believes that communication between government authorities and private companies on the matter of NFTs is crucial. “There needs to be an active dialogue. Then, the private sector can understand why the authorities are regulating NFTs. The regulations may be burdensome for some, yes, but it’s the duty and responsibility of governments to protect our economies and our investors.”

“The platforms involved in the trade in NFTs are not yet obliged to execute know-your-customer measures. Since there is little to no control, criminals have – as we say in The Netherlands – free play. These technological developments in the field of decentralised finance underline the need for international cooperation.”

In the meantime, one way to curb money laundering in NFTs and through other, traditional methods is to use specially designed anti-financial crime software. This is where Napier can help.

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Many of the money laundering risks associated with NFTs can be mitigated by the development of KYC best practices, strong cyber security, and the creation of a stolen art registry. But, regulation in the cryptocurrency industry is changing constantly.

Trade-based money laundering is already a problem in the art world, and NFTs could also be ripe for exploitation.

The easiest way to detect potential trade-based money laundering is to see whether the price of the transaction is in line with the fair market value of the item being transacted. For art, that would usually be the price recommended by an appraiser. Kenzo Tribouillard —AFP/Getty Images

Right now, NFTs are the hottest thing on the internet. Even if you don’t know exactly what they are, they’ve been absorbed so quickly into pop culture that even Saturday Night Live has done a skit about them.

Their meteoric rise has raised some questions, particularly among those who see parallels between the current thirst for NFTs and the excitement surrounding initial coin offerings (ICOs) a few years ago. The fear is that NFTs, like ICOs, could be exploited as yet another way to launder money in an anonymous and untraceable way.

The easiest way to detect potential trade-based money laundering is to see whether the price of the transaction is in line with the fair market value of the item being transacted. For art, that would usually be the price recommended by an appraiser. Given how new and how volatile the market for NFTs is at the moment, it is difficult to tell what a fair market price should be, especially where there are no precedents to rely on for guidance.

That’s why it’s important for businesses and individuals to be on their guard and to take every precaution they can, whether it’s running a quick automated background check on a new client or investing in a monitoring service to ensure that none of their existing clients are engaged in anything fishy, and an active approach to counter money laundering.

Martin Cheek is vice president at SmartSearch, a provider of an anti–money laundering verification service based in Lehi, Utah.

What is NFT Wash Trading?

Wash trading – a transaction in which the seller is on both sides of the trade to paint a misleading picture of an item’s value and liquidity – is an ongoing concern with cryptocurrency exchanges, some of which have attempted to inflate trading volumes.

US comedian and crypto investor Isaiah McCall, who created a 2021 blog titled ‘How to Launder Money with NFTs,’ warned that you could spend $1m of illegal money on your own NFT, resell it for nothing, and bank the profits.

A 2022 report by Chainalysis reveals that some sellers have conducted hundreds of NFT wash trades. The report shows that while most NFT wash traders were unprofitable, the top 110 profitable wash traders made a collective $8.9m in profit. Many purchases at NFT marketplaces were also shown to come from illicit addresses, used stolen funds, or came from addresses with sanctions risk.

Some NFT sellers are making a killing with wash trading

Let’s look more closely at Seller 1, the most prolific NFT wash trader on the chart above, who has made 830 sales to addresses they’ve self-financed. The Etherscan screenshot below shows a transaction in which that seller, using the address beginning 0x828, sold an NFT to the address beginning 0x084 for 0.4 Ethereum via an NFT marketplace.

Everything looks normal at first glance. However, the Chainalysis Reactor graph below shows that address 0x828 sent 0.45 Ethereum to that address 0x084 shortly before that sale.

This activity fits a pattern for Seller 1. The Reactor graph below shows similar relationships between Seller 1 and hundreds of other addresses to which they’ve sold NFTs.

Seller 1 is the address in the middle. All other addresses on this graph received funds from Seller 1’s main address prior to buying an NFT from that address. So far though, Seller 1 doesn’t seem to have profited from their prolific wash trading. If we calculate the amount Seller 1 has made from NFT sales to addresses they themselves did not fund — whom we can assume are victims unaware that the NFTs they’re buying have been wash traded — it doesn’t make up for the amount they’ve had to spend on gas fees during wash trading transactions.

Nonetheless, an interesting story emerges: Most NFT wash traders have been unprofitable, but the successful NFT wash traders have profited so much that, as a whole, this group of 262 has profited immensely overall.

The 110 profitable wash traders have collectively made nearly $8.9 million in profit from this activity, dwarfing the $416,984 in losses made by the 152 unprofitable wash traders. Even worse, that $8.9 million is most likely derived from sales to unsuspecting buyers who believe the NFT they’re purchasing has been growing in value, sold from one distinct collector to another.

How does the wash trade operate?

The intention of the parties participating in a wash trade and the outcome of that trade allows wash trading to achieve its goal.

When a trader simultaneously buys and sells tokens for the same asset, it is known as a wash transaction. On the other hand, the concept of wash trades goes a step further and takes the investor’s goal or aim as well as the outcome of the transaction into account.

Investors or traders should have bought and sold assets with common beneficial ownership within a short period to engage in wash trading. When referring to accounts, the term “beneficial ownership” is used. Trades across accounts with the same beneficial owner may concern financial regulators since they may signify activity. However, wash trades don’t always include actual transactions; they can also take place when traders and investors pretend to exchange assets on paper.

How are NFTs employed in the money-laundering process?

When NFT sales are directed at locations considered to be “self-financed,” NFT crimes, including money laundering and wash trading schemes, occur.

It’s understandable why has always been a concern in the art world. Because of their history and the anonymity of crypto assets, many people inquire whether NFTs are vulnerable to similar abuses. So, is it possible to launder money with NFTs?

Why does wash trading affect the NFT market?

Because these individuals use less liquid nonfungible tokens to affect an asset’s price, NFT wash trading is an issue for investors, the general public, collectors, and traders.

Because investors are now compelled to rely on quantifiable facts, they are more likely to make poor investment decisions, making due diligence more challenging. Specialists must look at data discrepancies to promote NFT investments and stop NFT scams. Moreover, the NFT community is the most severely affected by NFT crimes. Wash trading is now a tool that regulators and advocates of conventional financial services can use to fight decentralization.

People tend to respond hastily when misinformed facts and history about a work of art or collection lead them to believe something. Likewise, traders and collectors are unable to establish an intelligent opinion. Is there a technique to identify wash trading since it affects the NFT markets first?

When new coins are released onto the market, they have no prior price or volume history. Developers or other insiders may therefore engage in wash trading to mislead investors about the coin’s true value. So, stay away from funding those kinds of initiatives.

Furthermore, few NFTs have any investor interest or trading activity. As a result, NFT owners can easily engage in wash trading to persuade unsuspecting buyers to pay a hefty price for the NFT. The best strategy to avoid wash trading is to avoid newly issued small-cap cryptos and NFTs.

To prevent falling prey to wash trading, a trader must select more established cryptocurrencies with higher volume. Scammers will require more money to manipulate a larger market. For instance, crimes like wash trading are extremely difficult to commit with established cryptocurrencies like Bitcoin (BTC) or Ethereum, valued at hundreds of billions of dollars.

What are the Risks?

This technology can raise alarm bells from a money laundering and financial crime perspective. To start with, NFTs are most often purchased with cryptocurrencies on online marketplaces. Cryptocurrencies are routinely exploited for malicious means, such as obfuscating the source of criminal proceeds and, despite transactions being traceable, more sophisticated criminal actors use a variety of techniques to disrupt investigations by law enforcement.

A system of ‘know your customer’ policies and ongoing monitoring, similar to those used in the traditional art market and in compliant cryptocurrency exchanges, needs to be implemented

Along with the risks stemming from cryptocurrency usage, money launderers can exploit the trade and sale of NFTs in a similar way to which they exploit physical art.

Can These Risks be Mitigated?

Cryptocurrencies are regulated at the point of exchange to reduce the money-laundering risk. The same regulatory foundation can be applied to online auction houses for NFTs. Although the larger marketplaces are often linked to cryptocurrency exchanges, a baseline needs to be set for companies that want to focus on the NFT industry. A system of ‘know your customer’ (KYC) policies and ongoing monitoring, similar to those used in the traditional art market and in compliant cryptocurrency exchanges, needs to be implemented to ensure that the risk of money laundering is mitigated.

NFT marketplaces need to ensure that there is an option for two-factor authentication for consumers and confirm that cyber security measures are in place to protect against opportunistic hackers

The risks of NFT forgery and theft can also be mitigated. NFT marketplaces need to ensure that there is an option for two-factor authentication for consumers and confirm that cyber security measures are in place to protect against opportunistic hackers. In addition to the necessity of good cyber security, much can be learnt from how the traditional art market is regulated.

One solution that has been suggested is the development of a registry of stolen or fraudulently purchased NFTs. This would mimic the Art Loss Register, which in the real world lists stolen art and prevents its resale in legitimate auction houses. Some of the larger online auction houses for NFTs have already developed sections within their platform for tokens in which the claimed creator is verified.

With the development of guidance for KYC best practices, strong cyber security measures and a stolen art registry, many of the money-laundering risks of NFTs can be mitigated without restricting the growth of this new market. Implementation of these techniques will ensure that consumers can trade freely within the market without the fear of purchasing a forged NFT or having a token stolen.

The views expressed in this Commentary are the authors’, and do not represent those of RUSI or any other institution.

WRITTEN BY

Allison OwenCentre for Financial Crime and Security StudiesIsabella Chase

What are NFTs?

NFTs have existed since 2014 but are increasingly likely to come to firms’ attention through client transactions. Like physical artwork or collectibles, NFTs are unique or have a limited run, which means the amount NFTs are worth is subjective.

NFT money laundering activity is small but visible

So, are cybercriminals using illicit funds to purchase NFTs? Let’s take a look.

Value sent to NFT marketplaces by illicit addresses jumped significantly in the third quarter of 2021, crossing $1 million worth of cryptocurrency. The figure grew again in the fourth quarter, topping out at just under $1.4 million. In both quarters, the vast majority of this activity came from scam-associated addresses sending funds to NFT marketplaces to make purchases. Both quarters also saw significant amounts of stolen funds sent to marketplaces as well. Perhaps most concerningly, in the fourth quarter, we saw roughly $284,000 worth of cryptocurrency sent to NFT marketplaces from addresses with sanctions risk. All of that was due to transfers from the P2P exchange , which was added to OFAC’s SDN list last year.

We can see examples of different types of criminals buying NFTs in the Reactor graph below.

All of this activity represents a drop in the bucket compared to the $8.6 billion worth of cryptocurrency-based money laundering we tracked in all of 2021. Nevertheless, NFT money laundering, especially transfers with ties to sanctioned entities, represents a large risk to building trust in NFTs. This activity should be monitored closely by regulators, marketplaces, and law enforcement agencies.

This material is for informational purposes only, and is not intended to provide legal, tax, financial, or investment advice. Recipients should consult their own advisors before making investment decisions.

This website contains links to third-party sites that are not under the control of Chainalysis, Inc. or its affiliates (collectively “Chainalysis”). Access to such information does not imply association with, endorsement of, approval of, or recommendation by Chainalysis of the site or its operators, and Chainalysis is not responsible for the products, services, or other content hosted therein.

Chainalysis does not guarantee or warrant the accuracy, completeness, timeliness, suitability or validity of the information in this report and will not be responsible for any claim attributable to errors, omissions, or other inaccuracies of any part of such material.

What is NFT Money Laundering?

The regulation of NFTs is still in its infancy, as regulators and international bodies explore how they are used and how widespread adoption has become.

With increasing amounts of money – often cryptocurrency – being used to pay for NFTs, there are concerns that they may be used to circumvent expanding anti-money laundering (AML) rules for traditional art.

As the Directive doesn’t define what a ‘work of art’ is, or mention NFTs, it is unclear whether NFTs could be considered works of art and be subject to AML/CFT and Know Your Customer (KYC) practices under this ruling.

However, in 2020, the EU proposed a regulation that may apply to NFTs. The Markets in Crypto-assets Regulation (MiCA) defines NFTs as “a digital representation of value and rights which may be transferred electronically, using distributed ledger technology or similar technology”.

NFTs may fall under the ‘other crypto-assets’ category of the regulation – meaning issuers do not have specific licensing obligations, but are required to be a legal entity (even when being established outside the EU) and comply with specific business and governance conduct requirements.

In the US, while there is no direct regulatory guidance on NFTs, some states have created laws that could hold NFTs under their purview.

What is crypto wash trading?

To mislead other market players about an asset’s price or liquidity, a trader or investor who engages in wash trading repeatedly buys and sells the same assets over a short period.

Traders employ wash trading as a market manipulation strategy to affect an asset’s trading activity and price. As previously discussed, wash trading entails quickly selling and buying the same asset. Typically, one or more collaborating agents make several deals without taking into account market risks, which leaves the initial positions of the hostile agents unchanged.

NFT Money Laundering Risks

The risks around NFT money laundering are still emerging. The FATF is beginning to sketch out its approach to NFTs distinct from decentralized finance (DeFi), and this will likely shape how many major financial markets approach the issue.

Among the measures recommended to counter the risk of NFT money laundering are greater private sector information sharing to improve transparency in the art sector, and applying AML/CFT requirements, such as completing suspicious activity reports and KYC processes, to art market participants.

Can NFT Money Laundering Risks be Mitigated? If so, How?

Firms that haven’t done so should integrate NFT management into their risk assessments and risk-based approach to AML. RUSI guidance on how NFT money laundering risks can be mitigated sets out a regulatory foundation firms can start to build out/plan.

Ways to mitigate NFT money laundering include:

Why have NFTs become popular?

On top of this, NFTs are popular with creators who also want to prove the authenticity of their work. NFTs also provide the creator or artist with the ability to earn royalties long after the original sale of the virtual assets.

However, although these benefits are encouraging more artists to move online, a recent report from the Royal United Services Institute (RUSI) has outlined why money launderers who currently abuse the traditional art market may do the same in the world of NFTs.

How does Money Laundering Through NFTs Work?

While the ways that criminals can launder money are diverse, the basic principles of money laundering – placement, layering, and integration – apply to NFT money laundering.

As Financial Action Task Force (FATF) guidance states, much of the risk and regulation relating to NFTs and money laundering will depend on how they are being used and the nature of the asset that is traded.

In 2022, the US Treasury warned of the risk of NFT money laundering in the art sector. “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 shipmen,“ the report said.

The Treasury Department also flagged that criminals could self-launder money by purchasing an NFT, then passing it to themselves through different digital accounts, creating a sales record before selling to an unsuspecting buyer, and coming out clean on the other end.

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In conventional finance, wash trading is not permitted. On the other hand, in the decentralized world of non-fungible tokens, the legitimacy of wash trading has not yet been established (NFTs).

Even though there is no legislation or categorization for NFT, several governments have opposed it. For instance, a South Korean cryptocurrency exchange called Bithumb was charged for promoting wash trade worth more than $250 million in fictitious activity in 2018.

On April 5, 2022, Bloomberg reported that wash trading accounts for $18 billion, or 95% of the total trade volume on the NFT market called LooksRare. NFT tracker CryptoSlam provided this data.

This could be an interesting implementation, however if other projects start to “copy” this idea, then we’ve got a whole lot of wash-trading on our hands.

Also, read – Most Significant Moves Of Bitcoin Trading

Why are NFTs Attractive for Money Laundering?

While there is no evidence that money launderers are flocking to NFTs, facets of the trade of NFTs will seem appealing to potential criminals.

For example, a simple way to detect potential trade-based money laundering is whether the price of a transaction is in line with the fair market value of an item. But with the volatility of the NFT market, discerning a reasonable price for an item can be tricky – making it much easier for potential NFT money laundering.

And although NFT transactions have unique codes that are recorded on a public ledger, purchasers can remain anonymous, a big plus for anyone looking to wash assets discreetly.

There is also no mechanism to prevent launderers from creating multiple accounts and transferring assets to cover their trails further.

Some industry commentators believe the NFT money laundering risks are high, arguing that NFTs could be used to facilitate ML and tax evasion for the wealthy, as they face less scrutiny from regulators and lawmakers.

NFT money laundering scenarios could involve phishing and virus attacks, identity fraud, or forgeries.

What risks do NFTs pose?

RUSI believes that NFT technology “can raise alarm bells from a money laundering and financial crime perspective”. This is largely because NFTs are usually purchased with cryptocurrencies from online marketplaces. At present, these cryptocurrencies are routinely exploited for malicious means, including obfuscating the source of criminal proceeds.

On top of this, money launderers can exploit the trade and sale of NFTs. Sadly, we’ve already seen examples of NFT forgeries. For example, in March 2021, a hacker created a piece of digital artwork and put it up for sale on an online marketplace claiming it was a limited edition Banksy print. Thankfully, after it sold for $336,000, the hacker returned the funds.

How can we safeguard against these risks?

To reduce the risk of money laundering, NFTs are regulated at the point of exchange. But, although larger marketplaces are often linked to cryptocurrency exchanges, a baseline regulatory framework needs to be set for companies that want to focus on the NFT industry.

An essential part of this would be the creation of a system of KYC policies similar to those employed in the traditional art market and in compliant cryptocurrency exchanges. This would ensure the risk of money laundering is mitigated.

Similarly, the risk of forgery and theft can also be mitigated if two-factor authentication is implemented by NFT marketplaces and excellent cyber security measures are in place.

Finally, experts have also suggested that a register of stolen and fraudulently purchased NFTs could also be developed. This would mimic the Art Loss Register, which in the real world lists stolen art and prevents its resale in legitimate auction houses.