NFTs & the Threat of Rising Fraud

NFTs & the Threat of Rising Fraud

The popularity of cryptocurrency continues to skyrocket. In an estimated 567% increase from the prior year, 2021 saw a $15.8 trillion total crypto transaction volume1. NFTs also exploded that same year. Trading of NFTs increased by a significant 21,000% compared to the year before, reaching $17.6 billion in value.

Criminals are actively exploiting both crypto and NFTs for financial gain, whether it’s through crypto scams, phishing attacks or money laundering through digital wallets.

What’s an NFT?

Non-fungible tokens (NFTs), represent exclusive ownership of digital data or assets, commonly used for, but not limited to, digital art. Hosted on the blockchain and usually sold or traded using cryptocurrency, these tokens have a unique code or signature so that the original digital media cannot be interchanged with or be the same as another digital asset and can also be traced back to the original creator of the work. The owner of the NFT is the owner of that digital asset once it’s been purchased.

Not everyone believes in the hype of NFTs, but even still, the popularity of NFTs skyrocketed in 2021. This was particularly the case for art trading, especially when Christie’s, a well-known auction house, announced the record-setting $69.3 million sale in March 2021 of a piece of art by a single buyer from the digital artist known as Beeple, the record for digital art at that time. But that NFT didn’t hold the record for long, in December of the same year, Pak’s ‘The Merge’ made history as the most expensive NFT for digital art ever sold—bought for $91.8 million by almost thirty thousand buyers, each receiving their own token.

Acuant Infographic, NFT, non-fungible token, what’s an NFT, cryptocurrency, KYC, fraud, AML

Exploitation By Criminals

While the legitimate use of cryptocurrency is growing, the threat of illicit activity is still a significant issue in the world of cryptocurrency. Criminals, as they are wont to do, see popular trends as an opportunity for financial exploitation and fraud. It’s estimated that criminals got away with $14 billion worth of cryptocurrency in 2021, with $8.6 billion of that being laundered1.

Just as there is money laundering in the (physical) art and antiquities world, governments and regulatory bodies worry about the potential exacerbation of money laundering activity in the world of digital art and NFT marketplaces.

Some of the different types of fraud that the US Department of Treasury is speculating that criminals will use or exploit include:

  • Fake Transaction History: the rapid nature of transactions with digital art could result in an effective layering effect that creates a fake transaction history. Though this can be traced on the blockchain, it can be difficult to catch in real time if platforms facilitating these transactions are not following proper KYC procedures
  • Wash Trading: rapid transactions to other wallets also owned by the seller in efforts to make an item appear more valuable and thus drive up the price, manipulating buyers interested in the work
  • Asset-Based Lending: illicitly gained money turned to fiat money by investing laundered money into an NFT and applying for a loan where the NFT and its perceived value is used as collateral and perceived as legitimate

AML for NFT Marketplaces

Theoretically, platforms facilitating NFT transactions should be complying with regulatory Anti-Money Laundering (AML) standards, but these requirements aren’t heavily enforced yet, and many of these platforms likely don’t have a formal AML program (or are not yet incentivized to have one). On the flip side, platforms that are considered VASPs are subject to regulatory frameworks and would highly benefit from implementing a robust KYC program, at the very least. More so, the recent executive order on cryptocurrency by the current administration has indicated that the somewhat laissez-faire enforcement of such regulations is likely to change.

VASPs are Virtual Asset Service Providers (VAs are virtual assets). According to the Financial Action Task Force (FATF)2 VASPs are individuals or entities that operate as a business and offer at least one of the following services on behalf of another individual:

  • “exchange between virtual assets and fiat currencies;
  • exchange between one or more forms of virtual assets;
  • transfer of virtual assets [between one VA address/account to another];
  • safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets; and
  • participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.”

While certain AML regulatory frameworks that apply to VASPs may also apply to NFTs, not all NFTs are considered VAs under the FATF definition. A platform that offers NFTs that are used as payments or investment instruments may be considered a VASP and thus is obligated to regulatory compliance. A complete, end-to-end identity platform with automated KYC will be essential for VASPs and NFT platforms to effectively verify identities, prevent money laundering and comply with growing regulations.

Learn more about how Acuant’s KYC can help VASPs and NFT platforms ensure regulatory compliance.

 

Sources:
1 The 2022 Crypto Crime Report: February 2022,
Chainalysis
Virtual Assets and Virtual Asset Service Providers,
FATF

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