The U.S. Department of the Treasury published a study on Friday, Feb. 4 on money laundering and the financing of terrorism through the trade in works of high-value art, noting that the emerging digital art market, such as the use of non-fungible tokens (NFTs), may present new risks, depending on the structure and market incentives.
“Technological innovations, such as the rise of distributed ledger technology and NFTs, have presented and continue to present new opportunities for the exploration of creative media, and financial innovations in cross-border payments have allowed the global art market to thrive and expand,” the Treasury said in its statement.
2021 NFT Market Explosion
The NFT market exploded last year, and the Treasury noted that recent sales of high-profile pieces of physical and digital art involving NFTs, such as Beeple’s Everydays: The First 5000 Days, which sold at a Christie’s auction for more than $69 million, indicate that this nascent art sector has reached similar valuations to traditional art mediums.
This market generated $25.5 billion in trades, last year, 18,400% more than the four previous years combined, according to a recent DappRadar report, which adds that the first month of 2022 confirmed that NFTs are gaining even more momentum. Excluding LooksRare, which just launched Jan. 10 and has had $10.7 billion in sales volume, the NFT space amassed $5.3 billion in trades; almost 90% of which were transacted on OpenSea, DappRadar noted.
Ari Redbord, Head of Legal and Government Affairs at blockchain intelligence company TRM Labs, told GOBankingRates that the Treasury study is notable as it is really the first time that the Treasury Department — or really any global regulator — directly discussed the potential money laundering risks associated with NFTs.
“Treasury’s focus on NFTs — that can potentially transfer value at the speed of the internet — could be a sign that the regulator is studying this new technology more closely. This likely means that we will see more advisories and guidance from Treasury on NFTs and their potential use for fraud and financial crime,” Redbord said.
He added that one thing really important to note in any discussion of the comparative risks associated with physical art and NFTs is the fact that NFTs live and move on the blockchain, which is an open and immutable ledger.
“This means that while there may be less friction associated with moving NFTs, blockchain intelligence tools like TRM Labs are able to trace the flow of funds in ways that are impossible in physical art, which is famous for its private sales and opaque market,” he said.
The Ease of Laundering
The Treasury noted in the report that NFTs can be used to conduct self-laundering, where criminals may purchase an NFT with illicit funds and proceed to transact with themselves to create records of sales on the blockchain.
“The NFT could then be sold to an unwitting individual who would compensate the criminal with clean funds not tied to a prior crime. It is also possible to have direct peer-to-peer transactions of NFT-secured digital art without the involvement of an intermediary, and these transactions may or may not be recorded on a public ledger,” according to the report.
Another reason NFTs could be susceptible to money laundering is because these digital art assets are inherently easier to transfer between transacting parties than traditional art.
“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,” according to the report.
NFT Markets Need to Self-Regulate
Another reason for this market to be vulnerable to money laundering is the structure of the transactions in the market, which “can be different from the traditional art market as well, and these structural differences can create perverse incentives and money laundering vulnerabilities in the marketplace. NFT platforms range in structure, ownership, and operation, and no single platform operates the same way or has the same standards or due diligence protocols,” the report notes.
Jorge Pesok, General Counsel and Chief Compliance Officer for legal-first crypto software company Tacen Inc. told GOBankingRates that while the NFT sector presents incredible opportunities for artists and creators to monetize their work, there is also ample room for bad actors to use this emerging market as a means for fraud and other forms of illicit activity.
According to Pesok, the NFT market should heed this study as a call to self-regulate — or else risk being regulated.
“Though the study finds that approximately $3 billion is laundered through the art market per year, because many market participants voluntarily impose restrictions — such as not regularly accepting more than $10,000 in cash and conducting due diligence on potential buyers and sellers — the study concluded that comprehensive ‘anti-money laundering’ and ‘combatting financial terrorism’ requirements should not be imposed on the art market,” he said, adding that looking ahead, there will be more measures taken by NFT marketplaces, for example, to up their anti-money laundering and ‘know your customer’ protocols.
“I think a healthy balance can be struck in which participants self-regulate while also ensuring that this doesn’t hinder growth,” Pesok said.
“I think the NFT community should be prepared to work with authorities to make sure their platforms do not become havens for money laundering and terrorism financing. The major exchanges, like Coinbase, MakersPlace and FTX, are already working in this regard and so I think a healthy balance here can be struck, too.”
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