Non-fungible Tokens (NFTs) and Money Laundering

25 August 2022

AML, Private Clients, Blockchain & Cryptocurrency

What is a Non-Fungible Token?

Non-Fungible Tokens (NFTs) are non-interchangeable tokens stored on a blockchain or other form of distributed ledger. The tokens can represent any form or data, from a picture or video to a digital asset in a video game.

The Financial Action Task Force (FATF) defines NFTs as “digital assets that are unique, rather than interchangeable, and that are in practice used as collectibles rather than as payment or investment instruments”.

NFTs are generally not considered to be virtual assets (VAs) under the FATF definition. However, they may fall under the VA definition “if they are used for payment or investment purposes”. 

How are NFTs different from cryptocurrencies?

Unlike NFTs, cryptocurrencies are interchangeable, which means that every unit of cryptocurrency is the same. Just like with traditional fiat currencies every monetary unit of cryptocurrency is equal to one another while NFTs represent different types of data which as stated above vary widely among one another.

NFTs in the light of Money Laundering

NFTs in their nature come closest to digital works of art. At the same time NFTs represent a digital expression of this art, which makes them much easier to trade than the physical art we have known so far. Like cryptocurrencies, NFT can be transferred from one wallet or owner to another within seconds.

The above however is not the reason why NFTs are considered a risk for money laundering but rather their volatile and decentralised prices. While the exchange rate of cryptocurrencies to fiat money follows the market principles of supply and demand, the prices of NFTs are highly speculative. In practice, an NFT that was bought for EUR 1 can be sold for EUR 1 million the next day. This makes NFTs attractive for laundering money obtained through criminal activity through legitimate transactions.

What regulations are NFTs falling under?

With the implementation of the 5AMLD, the EU extended the coverage of its AML regulations to include cryptocurrencies. However, due to NFTs being cryptographic yet different because of their non-fungible traits, they are not necessarily covered in existing laws or often fall into grey zones. 

Back in September 2020, the European Commission presented a proposal for the regulation of cryptoassets, the Markets in Cryptoassets Regulation, or MiCA proposal. As part of this proposal, the EU for the first-time defined criteria for classifying a cryptoasset as a “digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology”. This would extend the coverage to at least partially include NFTs.

Mitigating AML risks

To achieve the goal of mitigating the AML risks, companies should strive to implement AML programs. This includes hiring compliance officers, adopting internal policies, implementing KYC tools and transactions monitoring, as well as evaluating clients’ risk profiles.

In support of the above, in 2019, the FATF issued an Interpretive Note to Recommendation 15 and revised its guidance on virtual assets. The documents clarified the definition of virtual assets service providers and their AML obligations, namely customer due diligence, KYC, recordkeeping, transaction monitoring, suspicious transaction reporting, and applying the risk-based approach.

There are a few proven ways to mitigate NFT money laundering, which include:

  • Implementing KYC policies and ongoing monitoring, similar to those used in the traditional art market and compliant cryptocurrency exchanges;
  • Ensuring there is an option for two-factor authentication for consumers;
  • Confirming cyber security measures are in place to protect against hackers.

How we can help?

New Balkans Law Office has a long-standing practice in advising our clients with a variety of topics related to cryptoassets and the related virtual assets issues. Our team can help in various ways from AML procedures to disputes. For more information, please read our related articles or contact us on [email protected] or via our contact form. 

 

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