Some NFTs Fall Under FinCEN Remit, U.S. Treasury Says

February 8, 2022
U.S. regulators weigh non-fungible tokens (NFTs) in the context of anti-money laundering (AML) for the first time, concluding that certain NFTs could be subject to U.S. AML regulations.

U.S. regulators weigh non-fungible tokens (NFTs) in the context of anti-money laundering (AML) for the first time, concluding that certain NFTs could be subject to U.S. AML regulations.

In its Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art, the U.S. Treasury says that certain NFTs could be considered virtual assets.

Similar to cryptocurrencies, NFTs are digital units, or tokens, on an underlying blockchain with a highly volatile value. However, as opposed to cryptocurrencies, NFTs are unique digital assets that represent ownership of images, videos, or other forms of digital property.

NFTs are often in the grey zone of regulatory frameworks, as they could be sold either as a piece of art, an investment, or could serve as a means of payment. In each case, different regulatory frameworks would apply to the product.

“As we tackle systemic challenges like corporate transparency and other loopholes that allow criminals to abuse the US financial system, we will look at what else might be needed to address money laundering risks specific to other industries, including the art industry,” said the aptly named Scott Rembrandt, deputy assistant secretary for strategic policy in the Office of Terrorist Financing and Financial Crimes.

According to U.S. authorities, in the first three months of 2021, the market for NFTs generated a record $1.5bn in trading and grew 2,627 percent over the previous quarter.

Although this is only a small share of the total U.S. art market, which was valued at more than $20bn in 2020, it is a fast-growing product and some examples are selling for similar high-level sums comparable to the great masters.

For instance, an NFT called Everydays: The First 5000 Days, created by digital artist Beeple, was sold for $69m at auction last year.

Now the Treasury says “depending on the nature and characteristics of the NFTs offered, these platforms may be considered virtual asset service providers (VASPs) by FATF and may come under FinCEN’s [Financial Crimes Enforcement Network] regulations.”

The study makes a distinction between NFTs that are used as collectibles, as these are generally not considered to be virtual assets under the Financial Action Task Force (FATF) definition, and those that are used as payment or investment instruments. The ones in the latter group could meet the FATF definition of a virtual asset, and platforms enabling the sale or purchase of these NFTs could meet the FATF definition of a VASP.

“In this context, some NFT platforms may qualify as VASPs, depending on the characteristics of the NFTs that they offer,” the Treasury says.

“Similarly, platforms or other persons doing business transferring virtual assets during the buying or selling of NFTs may have U.S. AML/CFT obligations under FinCEN’s rules for money service businesses if they are doing business in the United States,” the report continues.

VASPs that engage in the transfer of value that substitutes for currency are considered money services businesses (MSBs) and fall under the jurisdiction of FinCEN.

Such businesses are required to obtain a license to operate and must comply with AML rules.

Whether NFTs are considered virtual assets of the like depends on the “nature of the business dealing in NFTs and their function in practice as well as the facts and circumstances of the platform or other person doing business.”

The art of money laundering

NFTs could be exposed to money laundering risks for various reasons, the study finds.

Criminals can use illicit gains to purchase an NFT and sell it for clean funds that are not tied to a crime.

It is also possible to sell an NFT-secured digital art in direct peer-to-peer transactions, without the involvement of an intermediary, and without the transaction being recorded on a public ledger.

In addition, as digital art could be transferred across borders nearly instantaneously, it is much easier for criminals to move value without incurring potential financial, regulatory, or investigative costs of physical shipment.

Meanwhile, smart contracts used on blockchain typically generate revenue each time a transaction involving the NFT is recorded on a blockchain.

Although each NFT platform works differently, these types of contracts can create an incentive to shape a marketplace where the work is traded repeatedly in a short period.

Sometimes, the incentive to transact can potentially outweigh the incentive to verify the identity of the buyer of the work or create a situation where it is not possible to conduct due diligence if transactions are conducted in rapid succession.

Regulatory and non-regulatory tools

To address these issues, the study highlights there are a number of non-regulatory and regulatory options that the Treasury could consider.

For instance, without the need for making any regulatory changes, the Treasury could encourage the creation and enhancement of private-sector information-sharing programmes to foster transparency among art market participants, and update guidance and training for law enforcement and other agencies.

Regulatory options available include using FinCEN recordkeeping authorities to support information collection and enhanced due diligence, bringing certain art market participants under the AML/CTF legal framework, and obligating them to create and maintain AML/CTF programs.

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