The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) is considering how to regulate non-fungible tokens (NFTs), according to a report on its Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art. The report comes under a provision of the Anti-Money Laundering Act of 2020 that directed the Treasury Department to investigate the degree to which money laundering through the sale of artwork may affect the U.S. Financial system. The report is of interest not just to art collectors but also impacts the emerging digital-asset sector because of the potential for money laundering charges against those who participate in the NFT market.
Non-fungible tokens (NFTs) are part of the cryptocurrency market, but they are different from cryptocurrencies like Bitcoin, Ethereum, and other blockchain assets. NFTs are created as part of a platform that is built on an existing blockchain. But unlike other cryptocurrencies, NFTs are not fungible and cannot be traded or exchanged without an inherent diminution in value. An NFT is individually unique and uses blockchain technology to establish authenticity, ownership, and transferability of a unique asset.
An NFT is created from a digital object that represents both tangible and intangible property. NFTs are commonly used to represent artwork, videos, collectibles and antiques, video game avatars, and music. When someone buys an NFT, the purchaser receives exclusive ownership rights to the underlying asset. Blockchain technology allows artists, athletes, and celebrities to leverage their fame and talent to monetize themselves and their products. For example, an artist can create their own content and sell it directly to consumers as an NFT, thereby capturing most of the revenue generated from the sale.
NFTs can also be used in the financial services industry to fractionalize assets, such as real estate, making the underlying asset easier to divide among multiple owners. The NFT can then be traded on an exchange platform, creating new investment opportunities for people wishing to diversify their portfolios.
The FinCEN report identifies several qualities that make NFTs vulnerable to a wide range of financial crimes. These include subjective valuations and a lack of stable and predictable pricing, ease of transportability including transportation across international borders, and the accepted use of third-party intermediaries to purchase, sell, and hold artwork, which allows clients to remain anonymous.
The report identifies several instances in which these attributes of NFTs were used “to launder the proceeds of [ ] criminal conduct through the U.S. financial system.”
While the report signals the possibility that FinCEN will step up regulation of NFTs, the report indicates that regulating NFTs is not currently a priority, and that FinCEN is not currently requiring that NFT exchanges comply with Money Services Businesses (MSBs) requirements. However, NFT platforms should assess their obligations to implement know your customer (KYC) and anti-money-laundering (AML) procedures.
While the report expresses concern that NFT transactions may facilitate conditions for money laundering, it stops short of stating that NFT exchanges constitute a money transaction subject to ALM requirements.
To address the money laundering concerns identified in the report, FinCEN recommends:
FinCEN also cautions that traditional participants in the art market might not have the technical understanding necessary to properly identify and verify customers in the NFT space.
While savvy participants in the art market see the potential value of NFTs, regulators still view this new form of digital asset with concern. If FinCEN ultimately concludes that NFTs are a “value that substitutes for currency” NFTs would be subject to AML laws and regulations, and participants in the art market could face substantial legal hurdles. But before NFTs are adopted worldwide, government officials must provide meaningful guidance on the legal status of NFTs and how they will be regulated.