The art world has gone digital, thanks in large part to the advent of so-called non-fungible tokens (NFTs). NFTs, like cryptocurrencies, use blockchain technology (a disaggregated database made up of immutable blocks of data), which makes it possible to attach a unique authenticating token—sort of like a digital signature—to a digital item, most commonly a piece of digital artwork. The primary difference between an NFT and a unit of cryptocurrency is that one NFT cannot be exchanged for another—they are, as the name implies, non-fungible. That non-fungibility enables creators of digital art to sell NFTs of their work for profit. That’s important, because unlike traditional artwork, it’s extremely easy to create perfect copies of digital artwork. But one cannot simply copy an NFT. Of course, one can copy the image itself, but the copy, though identical to the naked eye, will lack the authenticating token. Why, you might reasonably ask, would anyone pay for an NFT when they can get the original image for free? Critics have raised these and other questions, but it seems that a sufficient number of people derive pleasure from collecting the original artwork, or from supporting the artists, or from the belief that the price of NFTs will continue to rise, that trade in NFTs has become big business. An artist known as Beeple sold one NFT for $69 million. Platforms from cryptocurrency exchanges to the hundreds-years-old art auction house Sotheby’s (and potentially the movie theater chain AMC) have entered into the growing NFT market; in the third quarter of 2021, the trading volume of NFTs exceeded $10 billion.
As in other emerging high-value markets, however, NFTs present a money laundering risk. Indeed, NFTs sit at the intersection of two sectors that are already characterized by high money laundering risk: fine art and cryptocurrencies. Because of the uniquely-high money laundering risk posed by these digital assets, FinCEN should issue NFT-specific anti-money laundering (AML) compliance guidance, and Congress should extend the Bank Secrecy Act (BSA) to apply to NFT marketplaces.
Before proceeding to regulatory solutions, it’s worth elaborating on why NFTs pose a significant money laundering risk. As just noted, NFTs are particularly high risk because they combine two sectors that are already characterized by high money laundering risk, albeit for different reasons:
- First, NFTs are vulnerable to money laundering because they are artistic. The value of art, whether traditional or digital, is largely subjective and contextual. One person’s trash is another person’s treasure, and one generation’s eyesore is another generation’s Van Gogh (literally). That means that it’s hard to predict, without context, how much an individual piece will sell for—and without a clear, objective basis for determining “fair market value,” it’s easier to disguise sham transactions. This problem is compounded with respect to NFTs, because in the online world it’s even easier to create legitimate-seeming artwork that is, in fact, worthless. Someone looking to clean dirty money could create a fictitious persona (or collaborate with another person), sell that “dummy” persona an NFT, and make the profits appear to be legitimate income from the sale. Traditional art sales try to avoid this problem by having appraisers identify the fair market value for a piece of art, and flagging as suspicious any transaction in which that piece sells for an unusually high or unusually low price. NFTs are much harder to value because their prices fluctuate erratically, and because there do not yet appear to be expert appraisers.
- Second, NFTs by their nature can only be bought and sold with cryptocurrency. Cryptocurrency transactions are a concern from an AML perspective because cryptocurrency transactions are pseudonymous (it’s the online equivalent of cash, but not tethered to an account with identification beyond the user’s public cryptographic key) and therefore hard to track. The much-lauded anonymity that blockchain offers as its greatest strength is also its greatest weakness for investigators––it’s just not clear who is buying what.
So, in NFT “marketplaces” (the websites that facilitate the NFT transactions), individuals buy and sell high-value items whose fair market value is extremely difficult to determine, and do so exclusively in the electronic equivalent of cash. These attributes heighten the risk that NFTs will be abused to launder dirty money. Yet these marketplaces remain under-regulated. Effective regulation is hampered in part by uncertainty regarding the appropriate regulatory scheme, if any, to apply to NFTs.
One possible regulatory response would be to treat NFTs like traditional artwork, and apply to NFT marketplaces the same AML rules that apply to markets for traditional art. That approach, however, is unlikely to be sufficient. The effort to secure AML requirements for art and antiquities sales has been long and arduous, and the existing protections are not particularly robust.
The more promising approach is to regulate NFTs as a form of cryptocurrency. The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) can and should apply its broad interpretation of “money transmission,” which covers assets that can serve as currency substitutes, as applying to NFTs, and should then move swiftly to issue NFT-specific guidance aimed at closing the NFT regulatory gap. This move would be similar to what FinCEN did for cryptocurrency prior to the 2021 expansion of the BSA . (That guidance should apply to NFT marketplaces, but probably not to non-marketplace platforms that incorporate NFTs, like video games with NFT characters, for instance.).
In the longer-term, legislatures should amend their AML statutes to expressly cover NFTs. For instance, the U.S. Congress should amend the BSA to include NFT marketplaces in the list of entities regulated under the Act. This expansion would mirror the extension of the BSA to cryptocurrencies as part of the Anti-Money Laundering Act of 2020. This explicit statutory authorization would allow FinCEN to impose reasonable AML requirements on NFT marketplaces.
As for the content of those regulations: While NFTs are a new technology, the nature of the necessary regulations is fairly familiar. The NFT marketplaces are best positioned to ensure that both the purchasers and the sellers are conducting legitimate transactions. While it’s easier to create a fraudulent online identity, NFT marketplaces can and should look into individual artists’ sales histories, require identity verification measures, and take other measures to ensure that users involved in large transactions are who they say they are (so-called “know your customer” (KYC) rules). Those measures would mirror the requirements already in place for financial transactions of this size in the physical world.
Critics would argue that imposing AML and KYC obligations on NFT marketplaces would stifle the development of this growing field. But there are no tenable alternatives. No incentives exist for NFT valuation and vetting; NFT marketplaces profit regardless of what types of users are deploying their services. And investigators can’t track all the transactions in this growing field without the marketplaces themselves flagging suspicious behavior. Whether it’s an established arthouse or a startup marketplace, companies shouldn’t profit from facilitating money laundering. And while more stringent regulatory requirements might stifle some lawful transactions, the AML gains are well worth the tradeoff.