NFT as the grey area of prevention of money laundering

Non-fungible tokens that are better known as NFTs have been shaking up the media as one of the biggest inventions after the bitcoin.  Although many of us have seen the pictures of monkeys wearing different hats or glasses, not many of us understand what NFT actually is.

Financial Action Task Force (FATF) defines NFT as digital (intangible) assets that are unique (unitary, irreplaceable) and used as collectibles rather than as payment or investment instruments.  For example, your first post on social media could become NFT because it is unique (namely, your name is on that post, your post is uploaded at a specific time, so there is no identical post in the world) and digital (intangible) and it floats on the internet like a code. Other examples of NFTs are digital tickets, contracts, elements of computer games, music or video records, cards, photographs, and other. In the physical world, an example of such asset could be a painted picture which is the only and unique thing.

According to the above definition, NFTs will not be understood as virtual assets within the definition of prevention of money laundering and terrorist financing provided by the FATF. However, if such assets are used for payment or investment purposes, they would fall within the definition of virtual assets. The latter is the most common type of NFTs. Individuals seek to sell their works, and buyers seek to buy them and later sell them for more. It should be noted that NFTs can only be bought using virtual currency, usually Ethereum, so buyers and sellers must have a virtual currency deposit wallet. When you buy NFT, it would fall into the same deposit wallet from which the virtual currency was sent.

It is important to keep in mind that the recommendations of FATF are not binding and that the Member States of the EU choose themselves how to implement money laundering requirements in their legal systems. In the Republic of Lithuania, the concept of virtual assets is not regulated at all. Only virtual currency exchange operators, depository virtual currency wallet operators and persons engaged in the initial offer of virtual currency (ICO) are recognized as obligated entities in the Law on the Prevention of Money Laundering and Terrorist Financing of the Republic of Lithuania. All such activities are inseparably linked to the virtual currency, which does not include the characteristics of NFT products.

Why is this important? 

Under current regulation, companies that act as intermediaries between buyers, sellers and exchangers of NFTs are not considered to be obligated entities. This means that such companies are not required to identify the buyers and sellers, to find out the origin of their assets, to report suspicious or high-value transactions to the Financial Crimes Investigation Service, or to comply with other requirements set forth in the Law on the Prevention of Money Laundering and Terrorist Financing. All transactions in such kind of markets can be made anonymously.

Such unregulated activities pose a risk to money laundering. It is a new medium for criminals to make huge transactions anonymously using virtual currencies. Simplified example of money laundering using NFT markets:

  • the criminal creates two anonymous virtual currency wallets and holds illegally obtained money in one of them and NFT created by him/her in the other;
  • the criminal creates two accounts in NFT market, places his/her NFT at the desired price and buys NFT from him/herself;
  • he/she declares cash withdrawals as those received from the sale of legal assets.

It should be noted that NFT markets that provide depository wallet services, i.e. provide the user with a wallet in which he/she can hold his/her virtual currencies and NFTs, should be considered as depository virtual currency operators and should be subject to the requirements of the Law on the Prevention of Money Laundering and Terrorist Financing, which would mean that customers would not be anonymous.

The current market of NFTs is expanding rapidly, i.e. it is noticed that the number of transactions is growing several times a year, the number and nature of NFTs are only increasing and even large corporations are getting involved in the issue of NFT. The second most expensive NFT amounted to USD 52,700,000, and the seller is still not identified.

Prepared by Inga Karulaitytė, the Partner of ECOVIS ProventusLaw, and Vilius Neverdauskas, the Associate of ECOVIS ProventusLaw


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