Money Laundering And High-Value Art: Treasury’s Study Discusses Financial Crimes And NFTs

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Money Laundering And High-Value Art: Treasury’s Study Discusses Financial Crimes And NFTs

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With the advent of blockchain technology, vendors are
increasingly accepting payments of goods, including artwork, with
digital currency. The decentralized nature of digital currency
makes it attractive for a lot of reasons, but it also makes legal
oversight a challenge. Add to that the emerging (or already
emerged) high-value market for digital art. For example,
Beeple’s Non-Fungible Token (“NFT”)
collection
 sold for more than $69 million at an auction,
and a CryptoPunk NFT sold for $23 million.

NFTs, which are often used as a digital tokenized representation
of a physical item, are susceptible to money laundering risks just
like traditional high-value art. The money laundering risks
presented by NFTs are not unique to NFTs, they are simply another
avenue that criminal actors attempt to exploit. However, because
NFTs are on a blockchain, they are publicly verifiable, auditable,
and digitally unique which makes thwarting bad actors possible. In
fact, a report from a blockchain analytics firm
found that in 2021 there was “small but visible” money
laundering activity in NFTs. The report continued, “[o]ur report
demonstrates that thanks to the inherent transparency of
blockchains, NFT platforms with the right data and tools can
effectively monitor their platforms to shut down and prevent abuse
such as money laundering.” These recent developments prompted
the Treasury Department to take a closer look.

On February 4, 2022, the Department of the Treasury published a study on the facilitation of
money laundering and terrorist financing through the art trade.
Among other considerations, the report discussed the risks of
financial crimes in connection with high-value art, including NFTs
(see our previous blogs about NFTs here and here). The study found that the high-value art
market has certain inherent qualities that make it potentially
vulnerable to a range of financial crimes, as we noted above. NFT
purchasers, marketplaces, issuers, and other intermediaries in NFT
transactions should be aware of the Treasury Department’s
interest in regulation and the potential for abuse through NFT
transactions.

Monitoring the movement of artwork is inherently more difficult
than tracing currency because there is no automated, mandated
electronic registry for artwork. This risk could be magnified in
the NFT context:

  • NFTs, like anything else of value, can be used to conduct
    “self-laundering,” a process by which criminals purchase
    a thing of value using tainted funds and proceed to sell and
    repurchase that thing of value to themselves in order to create
    seemingly legitimate sales. In the case of NFTs, the record of sale
    lives on the blockchain. The criminal then sells the
    “washed” thing of value to an unrelated party and
    receives untainted funds in return.
  • The structure of NFTs allows parties to transfer digital art
    without incurring potential financial, regulatory, or investigative
    costs related to the physical shipment of the art.
  • NFTs are pseudonymously held, which may make them particularly
    vulnerable to illicit use. However, NFTs are stored on a blockchain
    with a unique crypto wallet address. Some crypto wallets may reveal
    the identity of the owner, while others only reveal a string of
    characters known as a “public key.”

Digital art is one of the fastest growing sector of use-cases
for NFT technology. The Treasury study states that “in the
first three months of 2021, the market for NFTs generated a record
$1.5 billion in trading and grew 2,627 percent over the previous
quarter.” As a result, regulators are increasingly focused on
preventing the illicit use of the technology. The Treasury study
includes several considerations going forward for NFTs and other
high-value art market participants:

  • Encourage the creation and enhancement of private-sector
    information-sharing programs to foster transparency among art
    market participants;
  • Update guidance and training for law enforcement, customs
    enforcement, and asset recovery agencies;
  • Use FinCEN recordkeeping authorities to support information
    collection and enhanced due diligence; and
  • Bring certain art market participants under the U.S. Anti-Money
    Laundering (“AML”) and Countering the Financing of
    Terrorism (“CFT”) legal framework and obligate them to
    create and maintain AML/CFT programs.

Key Takeaways:

  • Stay ahead of the curve: assess whether your compliance program
    is compliant with AML/CFT obligations in the event NFTs come under
    their purview.
  • Have robust/comprehensive screening procedures: evaluate
    whether your screening procedures are sufficiently
    robust/comprehensive so as to know the ultimate natural owner of
    the artwork.
  • NFT market participants should be aware of any red flags in
    secondary marketplaces and of regulatory developments that could
    impact the industry.

Regulation is lagging behind this revolutionary technology. This
Treasury Department report is the latest in a series of studies and
reports by federal regulatory agencies that aim to warn investors
about the potential for abuse and provide a path for mainstream
adoption. This is a quickly-evolving area and we will continue to
update you on regulatory and compliance trends as they evolve.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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