Are NFTs Used in Money Laundering Schemes?

There’s a lot of buzz around non-fungible tokens (NFTs), especially in the last year and even recently. Hundreds of — maybe thousands — projects and marketplaces are initiated across the world every new day. Even though Ethereum remains the major blockchain network for minting NFTs, new blockchains are popping up for the same purpose

What are NFTs?

NFTs are essentially a type of digital artwork that can be purchased and sold on blockchain technology. In other words, each NFT is a digital asset created with its own unique digital signature. NFTs are created with the same technology and algorithms as cryptocurrencies like Bitcoin and Ethereum — namely, blockchain.

Bored Ape avatars

However, while cryptocurrencies and physical (fiat) currencies are “fungible,” that is, they can be exchanged or traded for one another, NFTs are not. Simply put, NFTs are non-transferable; that is, when someone acquires them, the original belongs to them and nobody else, even if others have similar copies. Like famous paintings like Picasso or Mona Lisa, there’s only one original NFT, and no duplicate can have equal or similar worth. This is possible as each NFT has a unique cryptographic key that defines it as the original.

However, while NFTs are similar to selling and buying physical paintings and other traditional artworks, there are quite a number of differences.

First, it’s relatively easier to create an NFT, and anything can be sold as such. Paintings, GIFs, pictures, videos, music, tweets, and so many other stuffs are now sold as NFTs. While an artist may spend weeks, months, or even years to create a single traditional artwork, an NFT can be created in a few minutes.

Also, the value of an NFT is subjective: its price is mainly determined by how much a potential buyer is offering. Popular examples of valuable NFTs are The Pixel, an NFT created by an artist known as ‘Pax’, sold at almost $1.3 million dollars at a Sotheby’s auction in April 2021. It’s simply a plain grey box! Similarly, Twitter co-founder Jack Dorsey’s first-ever tweet was sold as an NFT for over $2.9 million. To date, the most expensive NFT was created by Mike “Beeple” Winkelmann titled ‘Everydays: The First 5000 Days.’ Beeple’s digital creation was sold at Christie’s, a major auction house, at a whopping sum of $69.3 million! The digital art is simply a collage of 5,000 digital images!

Beeple art

What’s with NFTs and Money Laundering?

Money laundering, according to the Association of Certified Fraud Examiners (ACFE), is “disguising the existence, nature, source, control, beneficial ownership, location, and disposition of property derived from criminal activity.” In simpler terms, money laundering involves hiding or disguising the actual source of illegally obtained money.

Banks and traditional financial institutions are continuously monitored and scrutinized by the government to avoid money laundering. However, it’s concerning that money launderers often disguise themselves as art and antiquities collectors to go undetected. Since the actual worth price piece of art or antiquity is somewhat tricky to determine and easy to exaggerate, such transactions are often hard to regulate, and anomalies may go unseen. This could also apply to the digital world of NFTs.

According to the ACFE’s 2021 Fraud Examiners Manual, “As cryptocurrencies have become more widely adopted and used, they have been involved with a wide variety of fraud schemes, but perhaps none more so than money laundering. Converting illicit fiat currency proceeds into cryptocurrencies and then transferring cryptocurrencies through a complicated series of transactions across numerous wallets make tracing the illicit funds’ path tedious and difficult for fraud examiners or law enforcement.”

Essentially, since users are relatively unknown on the blockchain technology, they could disguise and simply acquire digital assets in a bid to “clean” stolen funds, and go unnoticed and obscure from law enforcement.

Even though NFTs, like cryptocurrencies, are created, sold, and acquired on the public-domain blockchain technology, they are still prone to abuse and misuse because of ​​the relative anonymity of the parties involved. There are different ways the platform can be abused, from money laundering, identity fraud to phishing, forgery, and other types of fraud. Not just theoretically, there have been cases of impostors posing as the real artists to sell NFT artworks and have successfully made away with the money.

For example, a user who theoretically creates an NFT, and puts the asset on sale on the blockchain. They can then purchase the NFT from themselves through an “anonymous” digital wallet with stolen money, and then claim the fund as legitimate proceeds from the sale of the artwork. Sadly, illicit transactions like these are difficult to trace and investigate, especially as NFTs are acquired and sold using cryptocurrencies, which adds an extra layer of complexity to the processes.

In the US, there are anti-money laundering laws in place to monitor, regulate and investigate the acquisition and sales of antiquities and artistic works. For instance, Congress enacted the omnibus National Defence Authorisation Act (NDAA), effective January 2021. The NDAA consists of reforms and updates to the Anti-Money Laundering Act of 2020 (AMLA), the Bank Secrecy Act (BSA), and the new Corporate Transparency Act (CTA). AMLA saddles the US Treasury Department with the responsibility of studying “the potential expansion of requirements to persons engaged in the art trade,” which may also apply to NFTs later.

NFTs and Money Laundering: What’s the Way Forward?

Up until now, there has been negligible NFT regulation around the world, and rightly so, since it’s still a nascent phenomenon in the crypto world. Even as different governments seek to prevent and investigate money laundering, the relative anonymity of blockchain users may pose a great risk to real-time regulation, preventive strategies, and punitive measures.

To manage fraud and money laundering through NFTs, financial institutions, investment bankers, and wealth management institutions must make extra efforts and deploy contemporary investigative strategies. For organizations with high net-worth clientele, they must observe, trace and verify the source of their clients’ wealth and funding, especially those whose portfolios include digital assets. Up-to-date analytics will allow them to observe and flag suspicious connections and questionable money flows.

NFT platforms need to invest in network analytics and work on vulnerabilities that malicious actors may want to exploit to launder money or commit other types of fraud. This will make their platforms safer for users who only want to make scrupulous transactions and may be afraid of the risks and threats.

However, for now, the onus mainly lies on users of blockchain technology, crypto enthusiasts, NFT collectors, and creators to keep their eyes peeled and stay informed of threats and potential dangers of the niche. While many users make efforts to transact transparently, there are other malicious elements willing to hide under the cloak of anonymity and exploit emerging technologies like blockchain for their own selfish gains and money laundering.