NFTs: Regulators Highlight Risks, But Dangers Remain

Non-fungible tokens (NFTs) seem to have emerged as the year’s most talked about asset. So it was maybe a foregone conclusion that global regulators would start making very clear warning noises about them. The only uncertainty is the effectiveness of such warnings.

The Joint Chiefs of Global Tax Enforcement – or to give them their snappier title, the J5 - issued a statement about the growing risks of money laundering and fraud associated with NFTs.

As a type of digital token and cryptoasset associated with the blockchain, an Non-Fungible Token'>NFT as a digital certificate of authenticity. All kinds of digital objects can be bought and sold as NFTs, including images, music, videos, books, virtual land and even tweets. And this, it appears, is concerning the J5.

The J5 includes the UK’s HM Revenue and Customs (HMRC), the US’ Internal Revenue Service Criminal Investigation Division, the Australian Taxation Office, the Canada Revenue Agency and the Dutch Fiscal Information and Investigation Service (FIOD). Its recent intelligence bulletin warns banks, law enforcement personnel and private individuals about the possible dangers of involvement with NFTs and lists possible signs of NFT-related illicit financial activity. The bulletin came out just before a meeting of J5 members in London, the purpose of which is to share data and “make connections’’.

As the J5 is an organisation that sees itself as leading the fight against international tax crime and money laundering, its warning about NFTs cannot be ignored. The cynical among us could even view the J5’s NFT statement as the clearest sign yet that this most high-profile development in the crypto world has now officially arrived as a tool of choice for those looking to make illegal gains.

There are clearly concerns about the volume of NFT-related crime that is being recorded – or at least fears about possible future amounts of wrongdoing that are anticipated. These, it would appear, are what have prompted the J5 to make its announcement. Such concerns are understandable: while NFTs are arguably the must-have cryptoasset of the moment, those who cast admiring eyes in their direction should not be blinded to the risks.

And those risks centre on the fact that NFTs are decentralised. This means they involve transactions between parties that do not use an intermediary, such as a bank or government institution. Added to this, NFTs are also unregulated, so they provide a convenient way of laundering money. While traditional art, such as a painting or a sculpture, is subject to specific regulations that have been designed specifically to prevent money laundering, there are no such obligations when it comes to the buying and selling of NFTs. This means that a situation can exist where A may sell an NFT to B without having to produce any documentation that can assist in validating ownership of the property. The risks are sizeable but may not be obvious to those who are not totally “in the know’’ when it comes to this latest, heavily-promoted asset.

One other area where NFTs differ from more conventional, tangible art is pricing. The prices of NFTs are less influenced by factors that affect the value of a traditional piece of art, such as age or condition. This means that pricing of NFT’s can be more subjective. While this is perhaps understandable, the downside is that it gives those involved in wrongdoing the opportunity to launder their money with very little suspicion being aroused. Paying what seems to be an unusually vast price for a painting is likely to raise a few eyebrows in the art world, spark some media coverage and even attract the attention of the authorities. With NFT’s, there is little or no scope for such an outcome.

Faced with the burgeoning popularity, lack of regulation and shortage of any reliable pricing associated with NFTs, the statement from the J5 is understandable. Whether it will prove adequate or worthwhile, however, is an entirely different matter. The factors that have prompted the J5’s warning have yet to be addressed by the authorities. Until they are, the dangers will remain.