25 Oct 2022

NFT Trading and Money Laundering: How KYC-Chain can Help

Non-fungible tokens (NFTs) have had a tumultuous yet impressive rise into the forefront of the decentralized digital economy.

First making a major mark in 2021 by offering an innovative and often lucrative new way for artists and other creators to monetize their productions, NFTs’ use cases have since been expanding into many other areas of digital finance and interactions – in particular in decentralized Web 3.0 platforms. 

As with many crypto-related assets, NFTs have also taken a hit throughout much of 2022. Despite this, the market cap of the sector has continued to grow. It was worth just US$13.7 million in the first half of 2020, rising to US$4 billion by the end of 2021 and is now projected to grow to US$20 billion over the next five years

The very concept of NFTs – providing a decentralized and robust form of digital ownership for their holders – makes their potential applications endless. From art to digital identity and Play to Earn (P2E) gaming, NFTs are fast becoming Web 3.0’s go-to medium for authenticating ownership and identity on the blockchain. 

NFTs are strengthening intellectual property protection through decentralization, democratizing the creative industries and providing much needed funding for innovative projects by allowing early-stage investors to acquire stakes through providing seed capital. 

Nevertheless, like most assets – whether new or old – NFTs can also be exploited for money laundering and other illicit financial activities. This vulnerability is particularly heightened by the lack of regulation of much of the space – though financial authorities are quickly gaining pace and expanding regulations to include NFTs too. 

In this article, we’ll take a look at how NFTs can typically be used for money laundering, how regulators are reacting, and how automated KYC solutions like KYC-Chain can help NFT projects and investors avoid falling victim to both financial crimes and regulatory sanctions.

NFTs: Money Laundering Risks

Money laundering has been a key concern of financial regulators and authorities globally since the 1980s. As the global economy became digitized, new opportunities for criminals to launder illegally-obtained funds have proliferated.

While the majority of money laundering activity still uses the traditional, fiat-based financial system, decentralized and often unregulated financial instruments such as cryptocurrencies and NFTs offer criminals a range of means for laundering funds. 

There are two characteristics of NTFs that make them especially appealing to criminals looking to launder funds: anonymity and value.

NFTs have caught the attention of global regulators because of how they can be easily purchased with high levels of anonymity, and then liquidated into crypto or fiat.

As the price of an NFT can be easily set by a seller, this provides an attractive window of opportunity for money laundering and tax evasion: financial criminals using multiple accounts can buy and sell the same NFT, exploiting price differences for tax evasion purposes or to pass off their illegally-obtained funds as legitimate gains from a lucrative a trade. 

In parallel, NFTs have also emerged as an attractive target for fraudsters who use a variety of different methods to steal them – indeed, between July 2021 and July 2022, over US$100 million worth of NFTs were stolen by criminals through various scams

As a result of the high-risk nature of NFTs from both a money laundering and fraud perspective, global regulators such as the Financial Action Task Force (FATF) have been issuing increasingly serious warnings to national regulators to update their financial regulations and oversight tactics for regulating the NFT trade. 

National financial regulators have already started clamping down on NFT-based money laundering: in the US, authorities recently charged two individuals for a US$1.5 million NFT scheme that defrauded unwitting investors before laundering the proceeds through cryptocurrencies.  Across the pond in the UK, this past January authorities made the country’s first seizure of an NFT as part of an investigation into a £1.4 million scheme that was using the digital assets as a means to launder proceeds from drug dealing. 

In parallel, authorities across the world are publishing new guidance on how to regulate the NFT sector. It is only a matter of time before financial regulations are expanded to include clear rules on how NFT trading platforms and vendors need to conduct Anti-Money Laundering (AML) processes when facilitating or engaging in NFT sales. 

The Role of KYC and AML

As the NFT market grows and becomes increasingly regulated, NFT trading platforms and issuers will have no choice but to take compliance with those regulations seriously.

That’s not a bad thing, as implementing AML measures – which are centered on Know Your Customer (KYC) processes – are key to protecting investors from fraud, while also improving the reputation and strengthening the long-term viability of the space

The big challenge for many NFT platforms/providers is how to efficiently comply with complex sets of diverse global financial regulations and the evolving threats of fraudsters in a way that is manageable and not prohibitively resource-intensive.

Ensuring that customers are who they say they are is a critical component of reducing NFT money laundering risk. This starts with identity verification tools that help confirm the identity of potential buyers or sellers by evaluating provided information and documents against government databases and money laundering and other compliance watchlists.

Automated KYC solutions such as what we provide at KYC-Chain are a powerful tool for any platform looking to grow in a secure and sustainable way in the NFT and crypto space. How our onboarding solution achieves that is the subject of our upcoming guide on Rising f Identity Theft and NFTs, which we’ll be releasing next month. 

Have any questions about how KYC-Chain can help your NFT project reach compliance and mitigate fraud? Get in touch and we can start a conversation. 

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