Author: Syedur Rahman
10 December 2021
2 min read
The surge in popularity of NFT’s since the start of 2021 is undeniable. The fact that the Collins Dictionary has made NFT the 2021 word of the year is proof of the huge surge in interest surrounding them. And yet they are not commanding universal admiration.
Rarity and demand have always driven prices up for just about every item that has ever come on to a market. Yet there has to be a concern that NFT’s represent unchartered digital territory, which makes them susceptible to criminal activity.
There are well-established fears that many NFT purchases are conducted to launder money, so that the proceeds of crime can be moved around, free from the watchful gaze of the authorities. Then there is the illegal practice of wash trading, where someone – sometimes with the help of a broker - will buy and sell NFT’s in order to mislead the market and make profits. While wash trading is not unique to NFT’s, the fact that they are a new and relatively under-scrutinised commodity makes them attractive to those looking to engineer such illegal gains.
It is also worth making the point that regulation and risk management are in their infancy regarding cryptocurrency on-ramps and off-ramps – where conventional currency is converted into digital assets and vice-versa. And while insider trading is illegal in most regulated capital markets, such restrictions do not exist for NFT’s. It does not take a genius to recognise how to exploit that loophole.
Yet the need for action has, at least in part, been recognised by the intergovernmental Financial Action Task Force (FATF). FATF’s recent guidance tells regulators when and how they should identify and regulate NFT’s as virtual assets.
This guidance clarifies that NFT’s are not considered virtual assets based on their general use. But the FATF does encourage the evaluation of NFT’s on a case-by-case basis. The FATF says that they should be regulated as virtual assets when the use of them conforms to the definition of a virtual asset, adding “some NFTs that on their face do not appear to constitute as virtual assets may fall under the virtual asset definition if they are to be used for payment of investment purposes in practice.’’
This is an approach that is rooted in the actual use of NFT’s as opposed to the technology. The challenge now facing those who are involved with NFT’s is to identify which NFT’s meet the FATF functional definition of a virtual asset. If the definition is satisfied, compliance and monitoring obligations will need to be met by the relevant parties. This in itself is a challenge, bringing as it does the need to take a risk-based approach to preventing unwanted customer transactions and ensure any suspicious incidents are flagged up swiftly. Regulators will be expecting those involved with NFT’s to be proactive when controlling risk. Yet such parties will also need to take care not to compromise the NFT user experience.
There remains a clear and pressing need for more regulation and a transparent legal framework regarding digital NFT’s. In the fast-moving digital environment, the NFT is currently the must-have commodity, as well as the word of the year. But there is still work to be done to protect investors and reduce the risk of NFT becoming a byword for criminality.
Syedur Rahman is known for his in-depth experience of serious fraud, white-collar crime and serious crime cases, as well as his expertise in worldwide asset tracing and recovery, civil recovery, cryptocurrency and high-stakes commercial disputes.