• Kirsten Saliba
  • 9 February 2022
  • 5.6 mins

When blockchain technologies first emerged, cryptocurrency was the main focus of admiration (and ire) across the globe, with Bitcoin taking up the majority of headlines before other currencies also began to permeate the public consciousness.

But more recently, the concept of Non-Fungible Tokens (NFTs) has almost hijacked the conversation. As more and more creatives turn to NFTs as a means of profiting from their art, and more and more of that art is sold for high figures, barely a day goes by when the subject of NFTs doesn’t come under some scrutiny.

And they are a good thing. This blockchain approach to ownership and authenticity is a revolution for the creative industry, strengthening IP and levelling the playing field. You no longer have to be a darling of the art world or have your piece in high profile galleries to make a profit from what you do. As with all things blockchain is working to reduce the wealth gap and give opportunities financially to those that have been denied for a long time.

However, as the world of NFTs grows, we realise so too do the risks associated with it. As the popularity of these tokens continues to soar it attracts the attention of hackers, thieves and other criminals looking to profit from illicit gains.

Illicit Financial Risks

On the 4th of February 2022, the US Department of Treasury announced the release of a “study on illicit finance in the high-value art market”. The study was mandated by Congress within the parameters of the Anti-Money Laundering Act of 2020.

The treasury wrote that the study “examined art market participants and sectors of the high-value art market that may present money laundering and terrorist financing risks to the US financial system.”

They believe that the burgeoning digital art market, including the use of non-fungible tokens, could present new risks, depending on the structure and incentives of the market.

With the money involved, it seems their concerns would be well-founded. According to Dappradar, NFT sales volume came to a total of $24.9bn in 2021, an astronomical leap from the $94.9 million it totalled in 2020. Analysts believe that the market for NFTs could reach $35bn in 2022 more than $80bn by 2025.

That the rising popularity of NFTs has attracted scammers has caused concerns among regulators.

It is believed that those most vulnerable to these illicit financial risks are businesses offering financial services that are not subject to anti-money laundering (AML) or counter-terrorism financing obligations, warning that asset-based lending can easily be used to “disguise the original source of funds and provide liquidity to criminals.”

T.K Keen, administrator for the Division of Financial Regulation for the US state of Oregon, warned in January that:

“Scams promising big returns on cryptocurrencies and NFTs are flooding the Internet. Investors wanting to purchase cryptocurrencies and NFTs should do their homework to make sure they fully understand these investments and their risks before getting involved.”

What are the Risks?

One of the main concerns with NFTs is money laundering. It should come as little surprise that digital money laundering should be a risk as this mirrors one of the biggest problems found in the traditional art world.

It is pretty easy to do, and you can find hundreds of articles on the internet in regard to it. But following that, it is also believed that high-value markets pose a credible risk of terrorism financing as well.

There have already been instances of money laundering scenarios if you look at the most expensive NFT arts sold online. One was a single pixel selling for millions of dollars. The buyer of that NFT remained anonymous, but no one in their right mind would pay that much for a single, nondescript pixel. So, it seems, in this case, it was used for money laundering; most likely purchasing the NFT with illegally acquired funds that now look legitimate through this NFT trade.

This kind of case can happen and seems to be happening already, for “cleaning” money and evading taxes, but when you consider its possibilities in the funding of terrorism or other criminal enterprises, it can become worrying.

But it’s not just money laundering, fraud can also be a risk in this art space. It is already believed there are a lot of phoney and non-precious NFTs floating around and masquerading as precious ones. Like traditional art, NFTs require a trained eye to decide whether it is worth investing in or not.

There is also the process of what is known as Wash Trading, where multiple accounts operate in tandem to inflate the price of an NFT to make them seem valuable.

Hackers are also a concern, they can copy an NFT token, make it seem legitimate and unsuspecting users can end up buying the fake NFT which has no value. In the US, the government is currently drafting a cryptocurrency bill that will define NFTs and provide an outline in regards to authentication, a boost to creators and investors alike.

What’s the Solution?

The US Treasury study recommended the consideration for several options to address the risks, including updating training for law and customs enforcement personnel, enhancing private sector information sharing and applying anti-money laundering and counter-terrorism financing requirements to certain participants in the art market.

However, it is said that this multi-billion-dollar industry, compared to other sectors that pose terrorist financing and money laundering risk, should not yet be an immediate focus for the imposition of regulations to combat illicit financing, but the threat is rising.

With NFT platforms themselves showing a reluctance to address the problems a lack of regulation can present; it is down to other technology platforms to pick up the slack. Developing tighter protocols and more comprehensive AML and KYC requirements can help protect people from the risks that the growth of NFT is bringing, and will afford protection while governments are still trying to figure out what needs to be done to protect people. Developing “compliance-as-a-service” as an internal industry solution can not only help prevent criminal activity but represent blockchain-based innovations as a more reliable and viable global solution for those still unconvinced.

If you or your project need an effective and dynamic AML solution, why not get in touch? We’ll be happy to discuss how we can make our tech work for you.

About Sekuritance

The Sekuritance RegTech platform provides a single platform for every eGRC need, including end-to-end AML/CTF, CECL, FCPA, vendor management, beneficiary onboarding, investor check, card processing MFA checks, blockchain wallet checks, cyber-risk assessments, and other RegTech or Business Process Management requirements.

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