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 a 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 collectables rather than as payment or investment instruments”.

NFTs are generally not considered 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?

Similar to traditional fiat currencies but unlike NFTs, cryptocurrencies are interchangeable, meaning every cryptocurrency unit has an equivalent value. NFTs, on the other hand,  are unique cryptographic tokens and thus represent different types of data.

Non-Fungible Tokens in light of Money Laundering

Although NFTs can be transferred from one wallet to another within seconds, the ease with which owners can trade NFTs is not why they are considered a risk for money laundering. Rather, they pose a risk because of 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. An NFT purchased for EUR 1, for instance, can be sold for EUR 1 million the next day. This activity makes NFTs attractive for criminal activities like money laundering.

What regulations are Non-Fungible Tokens falling under?

With the implementation of the 5AMLD, the EU extended the coverage of its AML regulations to include cryptocurrencies. Although NFTs are cryptographic, they are typically excluded from existing laws or fall into grey zones because of their non-fungible traits.

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

Mitigating AML risks

To mitigate AML-related risks, companies should strive to initiate AML programs, including hiring compliance officers, adopting internal policies, implementing KYC tools and transaction monitoring, and 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: 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, including:

  • 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 supporting AML procedures to aiding with disputes. For more information, please read our related articles or contact us on [email protected] or via our contact form. 

© New Balkans Law Office 2024

The Bulgarian and dual-qualified lawyers of New Balkans Law Office are regulated by the respective Bar of their registration. New Balkans Law Office is a brand name of Legal Services EOOD, a company registered under Bulgarian law. Reg’d No. 202331677. Further details are available here.

© New Balkans Law Office 2024