NFTs and money laundering, the perfect storm

In June, I wrote a story for Artnet (paywalled) describing how NFTs create new opportunities for bad guys to move money without attribution. Read the full story if you can. Otherwise, here are some of the points I touch on along with additional notes.

• The physical art world has a money-laundering problem — it is a secret world where expensive pieces are often bought and sold anonymously.
• Art is subjective, so it’s easy to justify spending millions of dollars on a piece. “This is a beautiful painting. I paid what I thought it was worth!”
• The art trade is not subject to the Bank Secrecy Act. In other words, the BSA does not consider art dealers, advisers, and auction houses to be financial institutions.
• Many collectors keep their art in freeports — ultra-secure storage facilities in tax-free zones near airports. They can sell their art to anonymous buyers, and the art itself never even needs to leave the warehouse. Thanks to middlemen and shell companies, the buyers often don’t know who the seller is either.
• A US Senate Permanent Subcommittee on Investigations report in July 2020 highlighted the extent of the problem. The report was devastating to the art world and pointed out the need to regulate the space.
• The art trade is already regulated in the EU, under the Anti-Money Laundering directives. 
• I like to compare buying an NFT to buying high-art in a freeport. You become the prestigious new owner, and you don’t even have to bother hanging the piece on your wall.
• Disclaimer: I know of no conviction yet so I can’t name anyone, but if you look through a pile of NFT transactions, you’ll see stuff that looks very odd and worthy of investigation.
• A lot of NFTs are bought and sold for crazy amounts of money — generally in the form of crypto — and often, we have no idea who the buyers or the sellers are. It’s not clear whether the platforms facilitating these trades know either.
• Earlier this year, two CryptoPunk NFTs sold separately for $7.5 million each in crypto — Punk #7804 and Punk #3100. In both cases, the buyers were known only by their crypto wallet addresses.
• In February, an NFT of Nyan Cat, a cat cartoon with a Pop-tart body, sold for $600,000 — in crypto. Again, the buyer was only known by their wallet address.
• Those are just a few examples. There are many, many others.
• The most practical way to launder money with NFTs would be via what is called “trade-based money laundering” — deals that appear legit on the face but are meant to hide the flow of ill-gotten gains. All you need are two parties to make that happen.
• Let’s say, I need to receive $3 million worth of dirty crypto. I mint an NFT, establish its value by wash-trading (selling back and forth to myself a few times) and then sell it to my colleague. I then cash out at a banked exchange. If anyone asks where the money came from, I simply tell them, “I sold an NFT!”
• Because regulations haven’t caught up with NFTs, some of the NFT marketplaces are relaxed in their anti-money-laundering and know-your-customer (AML/KYC) practices.
• Nifty Gateway, the NFT marketplace owned by Gemini, is centralized. All of its NFT trades are handled off-chain. Gemini is registered with FinCEN, and it’s widely thought of as one of the more regulated platforms.
• Also, it makes sense that Gemini would want to minimize risk and remain in good standing with the banks. (You can link directly to your bank account via Gemini. And you can purchase NFTs on Nifty Gateway with USD via your credit card.)
• However, other NFT marketplaces, such as OpenSea, Rarible, and Foundation, tend to be more relaxed in their AML/KYC.
• These exchanges are decentralized, meaning the backend code runs on the blockchain. Unlike Nifty Gateway, these platforms are non-custodial, meaning you always hold the keys to your own crypto. This is sometimes used as an excuse not to have a rigorous AML program in place.
• “KYC is only required when you buy crypto using OpenSea,” cofounder Alex Atallah told me. In that case, KYC is handled through Moonpay, a fiat onramp that lets you buy crypto with your credit card to spend on OpenSea.
• If you transfer your own crypto onto the platform and buy an NFT with it, OpenSea doesn’t ask who you are. Nor does the platform ask who you are if you sell your NFT for crypto and move your funds off the platform.
• All this will likely change.
• Regulators have their eyes on the art market — and the NFT market.
• On Jan. 1, 2021, Congress passed the Anti-Money Laundering Act of 2020, as part of the National Defense Authorization Act, with the biggest changes to the BSA in two decades.
• Among the changes, the AML Act extends the BSA to antiquities dealers.
• Antiquity dealers are now considered financial institutions with the same record-keeping and reporting requirements. It is up to FinCEN to spell out exactly how this will be implemented. FinCEN has until Jan. 1, 2022, to do so.
• The AML Act also commissions FinCEN to study the art market. If FinCEN finds significant links between money laundering and high art, it will likely recommend Congress extend the BSA to the wider art market, too.
• Experts believe this is very likely to happen. (As I mentioned above, it’s already happened in the EU.)
• The good news: There is still time for art dealers and auction houses to review and update their AML programs. (Christie’s and Sotheby’s, who have been auctioning NFTs, have likely already updated their AML programs in response to the Senate PSI report.)
• The AML Act also formally extends the scope of the BSA to crypto exchanges, in keeping with FinCEN’s earlier guidance that virtual currency businesses are money services businesses, and therefore, subject to BSA requirements.
• NFTs, on the other hand, aren’t mentioned in the new AML law. But they are not being overlooked either!
• In March, the Financial Action Task Force, a Paris-based AML watchdog, issued a draft updated virtual asset guidance, which could have implications for NFTs.
• In its draft, the FATF doesn’t specifically call out NFTs, but it replaces an earlier phrasing of “assets that are fungible” with “assets that are convertible and interchangeable” in describing the kinds of virtual assets that need regulation. (NFTs are convertible when you sell them for other forms of crypto.)
• This subtle change in language directly targets NFTs (and DeFi as well).
• If the US adopts the final guidance — which it most likely will — those subtle changes in wording give FinCEN the authority to regulate not only existing virtual currencies but also emerging asset classes such as NFTs.
• Additionally, NFTs could be considered art and NFT marketplaces could be considered art auction houses and get included in new BSA laws.
• Like high-art, NFTs hit all the right targets for money laundering.