06 Sep 2021

KYC AML for NFT marketplaces

In basic terms, NFTs are a certificate of ownership that is stored on a blockchain. They are non-fungible as they are unique and cannot be replicated - even if the digital item they denote ownership of can. 

NFTs have therefore attracted significant attention from the creative industries, as they present a new opportunity for artists and other creators to capitalize on their productions. At the same time, they offer would-be buyers and investors the chance to own a creator-sanctioned ‘original’ copy of a piece of art. This ownership is verified and actualized on a decentralized blockchain. 

However, the way that NFTs are traded has been quickly identified as a potential hotbed of money laundering activity. 

As NFT marketplaces are not (yet) explicitly regulated by most global regulatory regimes, many of them do not implement KYC measures to ascertain and verify the identity of the people who use their services. 

This means that someone can effectively purchase an NFT for a large amount of money, then sell it to a third account (that they indirectly own) for a lesser amount of money, and effectively reduce their tax liability. This is just one of the ways that analysts have predicted the space could be exploited for money laundering purposes. 

In parallel, NFT marketplaces work largely on the premise that individuals who offer NFTs for sale are in fact the actual owners of the items the NFTs denote ownership of. Exercising KYC to verify true ownership of an NFT is still significantly lacking in many NFT marketplaces, opening up the possibility of individuals who are not actually an owner / creator of a piece of art or collectible from fraudulently cashing in on someone else’s work. 

KYC for NFTs: Why is it necessary (and important)?

We’ve already written an article discussing how and why NFT marketplaces would be well-advised to institute KYC on their platforms. 

In short: although NFTs are not yet explicitly mentioned in any global financial regulations - such as those developed and implemented by the FATF - they can nevertheless fall into categories that are regulated, such as Virtual Assets (VAs), investment tools and artworks. 

With this in mind, businesses that have emerged as conduits of NFT trading would be best advised to not wait for regulation to catch up with them - but to act ahead of the regulatory curve and establish protocols that preempt the space being exploited by criminals. 

As well as preparing for the likely arrival of future regulations, this can also serve to lessen the potential that regulators take a harsher stance on the industry in the future. That prospect will turn into a very real possibility if the latter were to expand in a messy, unregulated manner that is heavily-exploited for money laundering and other criminal activity. 

By implementing effective, robust and efficient automated KYC onboarding, NFT marketplaces can therefore achieve the following goals:

  1. Prepare for impending regulation - establishing the technical and human infrastructure required for compliance before it becomes a critical necessity can allow NFT marketplaces to make smarter and more considered decisions, and not be caught off guard when regulation does arrive. 
  2. Prevent money laundering on their network - by instituting a robust AML protocol that includes effective KYC, NFT marketplaces can reduce the risk of money laundering and allow the broader sector to evolve in a healthy way - and mitigate the risk of more severe regulation in the future. 
  3. Establish trust with users - NFT marketplaces that prove they take compliance and AML seriously can gain broader acceptance and attention from accredited and established investors. 
  4. Mitigate the chance of intellectual property theft and fraud - this is absolutely critical for the industry as a whole, as NFTs’ key attraction and selling point is that they offer a verified and authentic certificate of ownership that has been sanctioned by the creator or owner of a piece of art. Robust KYC can assure users that the NFTs they purchase are verified and real. 
  5. Secure access to the global financial system - the power of NFTs to serve as an effective denotation of ownership will rely on their owners’ ability to cash out the funds they receive for selling them. Banks are extremely risk-averse when it comes to transactions with entities that do not have verified AML credentials.

What would KYC for NFT marketplaces look like?

Some platforms already choose to conduct a more basic KYC process for all general users of their platform as a Tier 1 onboarding process. This is designed to ensure users are who they say they are, as a means of countering fraudulent sales and intellectual property theft. Nevertheless, even this basic level of KYC is still painfully lacking on many NFT platforms - a situation that threatens to undermine the credibility of the space as a viable means for artists and creators to be rewarded for their productions.

As a Tier 2 onboarding process, NFT platforms that want to ensure compliance and mitigate money laundering risks will need to implement KYC when sellers want to withdraw crypto from the platform after a sale. This level of KYC can help prevent NFT platforms from being exploited by criminals for financial gain, and can help shield platforms from expanding global financial regulations if and when they begin to apply to actors in the space. 

Do you have an NFT project that needs efficient, fast and scalable KYC onboarding? Get in touch and we’ll be happy to discuss how KYC-Chain can be customized and implemented for use on your platform. 


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