US Treasury Department Warns of NFT Risk in Art-Related Money Laundering

The U.S. Department of the Treasury warned that non-fungible tokens (NFT) may become a tool for money laundering in the high-value art market in a study published Friday.

The 40-page report, published in accordance with the Anti-Money Laundering Act of 2020, found there is some evidence to suggest high-value art is involved in money laundering, but likely not in any terrorist financing. However, the document did suggest NFTs could be used to facilitate more illicit transactions in the art market.

"The emerging digital art market, such as the use of non-fungible tokens (NFT), may present new risks, depending on the structure and market incentives," a press release said.

Art is relatively easy to transport and the art market has a "long-standing culture of privacy" that can enable easily manipulated prices, making high-value art vulnerable to money laundering, the report said.

Different pieces of artwork have already been used to cover up the transfer or holding of funds acquired illicitly, the report said, pointing to the 1MDB scandal as one example.

NFTs and the broader, growing digital art sector can present new money laundering issues.

Read more: New Chainalysis Report Suggests NFT Crime Doesn’t (Always) Pay

"Recent sales of high-profile pieces of physical and digital art involving NFTs, including NFT-authenticated works such as Beeple’s 'Everydays: The First 5000 Days,' which sold at a Christie’s auction for more than $69 million, indicate that this nascent art sector has reached similar valuations as traditional art mediums," the document said.

The NFT market saw $1.5 billion in trading in the first quarter of 2021, compared to the $20 billion seen by the U.S. art market through all of 2020. Still, the report noted that legitimate auction houses and art dealers "are increasingly offering NFTs," and highlighted the growth of platforms such as Dapper Labs, OpenSea and SuperRare.

These platforms might be considered virtual asset service providers (VASP) by the Financial Action Task Force (FATF) and therefore be subject to existing know-your-customer (KYC) and anti-money laundering (AML) laws.

The report also warned of the possibility of wash trading with NFTs.

"Furthermore, NFTs can be used to conduct self-laundering, where criminals may purchase an NFT with illicit funds and proceed to transact with themselves to create records of sales on the blockchain," the report said. "The NFT could then be sold to an unwitting individual who would compensate the criminal with clean funds not tied to a prior crime."

The report went on to say that some transactions may not be recorded on a public ledger, or could otherwise bypass any regulators or investigators watching for illicit funds.

Smart contracts designed to automatically ensure the original artist receives royalty payments every time the NFT is sold could inadvertently encourage transactions that avoid the regulatory net, the document said.

"These types of contracts can create an incentive to shape a marketplace where the work is traded repeatedly in a short period," the report said. "While this can ensure that artists are compensated for their work past the first sale, the activity can pose [money laundering] vulnerabilities because the incentive to transact can potentially be higher than the incentive to verify the identity of the buyer of the work, or even can create a situation where it is not possible to conduct due diligence if transactions are conducted in rapid succession."

What's more, auction houses may not be able to keep up with these transactions or verify buyer identities due to a lack of technical wherewithal, the report said.

The report recommended that the Treasury Department weigh the costs and benefits of applying anti-money laundering and counter-terrorist financing rules to art market participants, including possible customer identification and suspicious activity report rules.

No NFT-specific recommendations were made. While the report identified potential vulnerabilities, it noted that entities of different sizes would have different levels of risk.

The report said the Treasury Department should consider whether it should have a transaction or sales volume threshold for reporting requirements, whether it should enact AML rules in compliance with international standards and whether high-value art should have different rules than lower-value transactions.