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The Joint Chiefs of Global Tax Enforcement (J5) have published a new intelligence briefing warning of the financial crime risks of non-fungible tokens (NFTs).
The NFT Marketplace Red Flag Indicators represents the first issued guidance on NFTs from the J5, a group comprising the heads of tax enforcement administrations from the UK, the US, Australia, the Netherlands and Canada.
In the briefing, the J5 lists two tiers of warning signs — “strong” and “moderate” — that should alert market participants to the risk of financial crime when handling or purchasing NFTs.
Given the speed at which the NFT ecosystem is evolving, the J5 said the two lists are not intended to be exhaustive.
However, the briefing document does bring together best practices from each of its five members and draws on their knowledge of NFTs gathered through their own investigations.
For example, among the "strong indicators" of financial crime are red flags such as:
- A newly-minted or secondary-market NFT fetching more than $100,000, but with no observable community behind it.
- A network of sending and receiving parties to the same NFT transaction or group of transactions.
- An NFT that is sold at a high price point immediately after minting, or an NFT that is sold for a high price and then reacquired by the same party or a third party at a lower price.
- A clearly overpriced or underpriced NFT that is traded frequently in a short period of time.
- Wash trading, i.e., artificially increasing the sale value of an NFT with each sale between linked accounts.
- An incorrect NFT mint address, i.e., the contract address does not match the address provided on the NFT project website.
Emerging crime in an emerging market
Although the J5 said the majority of people who trade cryptocurrency or NFTs do so for the right reasons, it warned that with any new technology, criminals will look for ways to exploit it.
“This space is changing so fast, and technologies and products have the ability to become the ‘next big thing’ without any due diligence or regulation on the part of the creator of the product,” said Oleg Pobereyko, special agent and crypto group lead at J5.
“We tried to put together a product that would help keep people safe while law enforcement catches up to these particular concerns.”
Among its other proposals, the J5 said that high-quality data should be leveraged by NFT marketplaces to help identify and combat financial crime and fraud.
For example, marketplaces could identify suspicious activity based on transactional data alone, or they could use KYC or other client-relationship data to improve supervision.
As the J5 pointed out, however, it is unlikely that using a single indicator in isolation will provide definitive evidence of fraud, so indicators ought to be “compounded” to produce more reliable signals.
Will Day, J5 chief and deputy commissioner of the Australian Taxation Office), said that with the growing popularity of crypto as both an investment and as a currency for NFTs, the time is right for the J5 to offer more detailed guidance on the issue.
“This paper provides a suite of indicators that financial institutions can reference to help them identify illicit financial activity concerning NFTs,” he said.
Jim Lee, chief of the US Inland Revenue Service (IRS) Criminal Investigation bureau, said he hopes that the NFT briefing document is the first of many that will be produced by the J5.
“We are doing incredibly innovative things in the J5, and the lessons we are learning are cutting edge,” he said.
“Sharing that information with the public and private sectors can only help to stop various types of fraud before they become the next case on our investigative inventory.”
Next steps
Next month, J5 members will gather in London for a series of meetings, including the J5 Challenge.
Using a range of analytical tools, experts from each country will be put into teams and challenged to generate new leads and spot tax offenders who use cryptocurrency, based on the new data made available to them on the day.
Working within existing treaties, the J5 said that data sharing during the event can help lead to immediate detection of fraud and financial crime, which could otherwise take years to identify.
