The NFT market needs AML compliance. Here’s what businesses should do.

January 24, 2022
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NFTs are here to stay. But regulators are beginning to crack down on financial crime in the space. If you work with NFTs, here’s what your business needs to do to keep operations above board and compliant.

Reports of rampant money laundering, wash trading, and fraud have led to increased scrutiny on the NFT marketplace in recent months. Yet NFTs are more popular than ever. 

While most people around your typical office watercooler probably still don’t even know what an NFT is, the market has exploded since it poked through to the mainstream over the past year.

Estimates show that in that year, the market surpassed $40 billion. And some investors think that market cap will double by 2025. Even legacy retailers like Walmart are quietly kicking tires around the metaverse.

Some fad!

Whether you’re already a business owner in the crypto space, or a new entrepreneur/artist, there are attractive financial opportunities in NFTs that are hard to ignore.

But regulatory scrutiny in the space is going to increase, and you’re right to wonder whether or not it’s safe or advisable to explore NFTs. 

While we wrote a blog post several months ago offering some initial thoughts around NFT compliance, best practices have sharpened since.

If you’re looking at the opportunities in the NFT space, but want to proceed cautiously and operate in compliance with the relevant laws and regulatory guidance, this blog post will get you started on the right foot.

Let’s dive in!

Financial crime in the NFT marketplace 

There are no bones about it. The NFT marketplace is rife with financial crime. 

As we’ve seen with other crypto innovations, when something takes off, criminals and fraudsters also take notice and are attracted to the same opportunities as your average consumer. 

It’s important to understand the scope and makeup of financial crime in the NFT space for a few reasons. One, because regulators have not issued specific guidance on NFT compliance. Two, because despite point number one, regulators expect compliance with existing regulations, even though sometimes that creates square peg situations.

Three, understanding how financial crime in the NFT market works will directly inform the compliance countermeasures you put in place.

So, let’s take a look at potential illicit activities in the NFT space.

Of primary concern is trade-based money laundering or TBML.

TBML involves using the trading of assets to disguise a potentially criminal source of funds. A few more trades of a given asset are conducted creating a “paper trail” that can disguise the origin of funds, making them appear legitimate.

Traditionally, TBML schemes can be quite complex. Real-world assets like real estate, vehicles, or even rare art are traded, purchased, and re-purchased to disguise ill-gotten gains. 

But digital assets like NFTs can potentially remove a lot of complications from TBML. You can imagine a money launderer creating a simple .jpg, listing it as an NFT for hundreds of thousands of dollars, and then re-purchasing it using ill-gotten gains, thereby separating the funds from their criminal origins in just a matter of clicks. 

This example, among other concerns about money laundering in the NFT market, are articulated particularly well in the following video from finance YouTuber Greyson Roberts:

Another typology that we’ve noticed emerging in the NFT market involves a fraudster listing and purchasing their own NFTs over and over, creating a false impression of market demand. 

The fraudster will then list the NFT at a “discount” and attempt to sell it to an unsuspecting buyer. This buyer will assume the NFT is popular and valuable based on prior activity when in reality, the fraudster has artificially driven up the price.

In addition to these, reports of miscellaneous fraud, IP theft, and even tax evasion in the NFT space collectively add up to billions (yes, with a “b”) of financial crime in this nascent market.

That much financial crime in such a short period has naturally caught the attention of regulators. The IRS has already been swift to crack down on tax evasion, with felony charges looming like an axe over NFT sellers.

But a larger proactive regulatory framework for the marketplace is in play. Make no mistake. This market is ready for AML compliance now.

So if you’re interested in the opportunities in the NFT market, here is what you need to do now to proactively practice compliance and lay the groundwork for new regulations to come.

Best practices for NFT compliance 

An AML Program

A critical first step for any business involved in trading of NFTs or other activity is to proactively implement an AML compliance program. This program specifically should include robust Know Your Customer/Customer Due Diligence (KYC/CDD) information gathering and verification.

AML compliance in crypto can be tricky, since many regulations designed for the financial system of the 1970s can be awkward fits for the digital era. But regulators have demonstrated willingness to open dialogue with the crypto space to create frameworks that curb financial crime without limiting innovation.

As a business owner, proactively implementing AML compliance shows regulators that you share their concerns for financial crime in the space, are dedicated to protecting your customers, and are committed to a safe and fair marketplace.

But like we said, the devil is in the details. If you need help or have questions, you can reach out to us for a free consultation

Clearly defined red flags

Recall that we spent a good amount of time earlier talking about the specific character of financial crime in the NFT space, because it would inform AML countermeasures. Here’s where the rubber meets the road.

Red flags and alert routines for NFT products and services will need to be heavily customized around some of the themes identified earlier (TBML, wash trading, etc.).

You will need to keep a watchful eye on transactions for any signs of scams or other potentially illicit activity common to the NFT marketplace, and don’t rest on your laurels here; the nature of illicit activity in this market will evolve, possibly quicker than you expect.

A good place to start here would be to research existing red flags in traditional marketplaces around some of the typologies identified above, and then apply some “tweaks” to customize those alerts to the realities of the metaverse/NFT products. 

Open source tools

Be on the lookout for open-source tools, like blockchain explorer tools, that aid your investigative efforts.

While there are a number of crypto tools that could be useful here, keep an eye out for new NFT-specific tools as well. For instance, this tool from Etherscan is an open-source blockchain analytics tool that includes a tracker for NFT projects.

This tool is a significant asset for NFT due diligence, and as the NFT marketplace grows, more tools that can be used to enhance AML protocols are certain to debut.

Key takeaways

NFTs aren’t going anywhere, and the opportunities for business owners and entrepreneurs are promising.

However, increased regulatory scrutiny is to be expected, and regulatory interventions thus far have been severe (to match the breadth and scope of crime in the space).

The solution? AML compliance.

Best practices have evolved in recent months, and anyone interested in NFTs has enough resources at their fingertips to pull together AML compliance countermeasures sufficient to protect their business and the wider marketplace from criminals. 

That will be the perspective of regulators when they come knocking, asking about your NFT compliance. Don’t be caught flat-footed.

If you have any questions about NFT compliance or AML compliance for cryptocurrency writ large, you can reach out to us for a free consultation here.




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