Art Has a Money Laundering Problem. NFTs Could Make It Worse



Non-fungible tokens (NFTs), blockchain-based title deeds tied to digital or physical items, have exploded into the art world like an upstart rebel fresh out of art school, tearing up conventions and leaving the establishment bewildered.

In recent months, multi-million dollar sales of NFTs at venerable auction houses Christie’s and Sotheby’s have grabbed headlines. Overnight, digital artist Beeple became a household name and one of the highest-earning living artists. Artworks by Banksy are being torn up and turned into NFTs, while Russia’s iconic State Hermitage Museum has announced an exhibition of NFT art.

Art critics have scrambled to form opinions on this new wave of digital artists. And the world’s highest-valued living painter, David Hockney, spoke for many in the art establishment when he dismissed NFTs as being for “crooks and swindlers.”

He may have a point—but if NFTs are the preserve of crooks, they’re only amplifying an existing problem in the art world, which has long been criticized for facilitating money laundering. Indeed, last year the U.S. Senate released a 147-page report focusing on the connections between high-end art and money laundering.

In 2018, the IMF estimated that the legitimate art market was worth around $68 billion. At the time, the UN claimed the illicit art market was worth roughly $6 billion. And according to Jordan Arnold, chief innovation officer and global chair of private client services at risk and compliance firm K2 Integrity, the problem is likely to get worse as new art mediums such as NFTs emerge.

“As the global economy has grown and nefarious actors find both new art mediums and new ways to circumvent safeguards, it is likely the number—whatever it actually is—has only grown,” Arnold told Decrypt.

Highest Valued Living Painter David Hockney: NFTs are for 'Crooks and Swindlers'

Cat Graffam, an adjunct faculty member in the Art & Design department at Lasell University, agrees. “I think it is possible that NFTs could be and are already being used to launder money in similar ways done with physical art,” she said, adding that NFTs offer some advantages to criminals over conventional physical artworks. “It could possibly be even easier to move dirty funds around, because it is tied to a decentralized currency and the fact that there are no physical artworks to have to transport or store in off-shore tax haven warehouses.”

"I think it is possible that NFTs could be and are already being used to launder money in similar ways done with physical art."

Gabriel Hidalgo, managing director at K2 Integrity, agreed. “The lack of customer KYC on some NFT marketplaces creates pathways to circumvent identification,” he told Decrypt.

Now the world’s financial services regulators have taken notice of NFTs. The Financial Action Task Force (FATF)—a global anti-money laundering watchdog in France—recently published draft guidance that categorized decentralized finance operators as Virtual Asset Service Providers (VASPs).

“Perhaps it was the Beeple effect that made FATF think twice about the risks posed by NFTs as it was finalizing the draft,” Lewis Cohen, co-founder of blockchain legal firm DLx Law, told Decrypt last month.

If that draft guidance gets formally adopted, it means that decentralized finance platforms will have to do their bit to combat global money laundering. What’s more, NFTs and the platforms that trade in them could end up forced to comply with the same FATF guidance.

Art and dirty money

The art industry has long been criticized for making it easy for criminals to launder their ill-gotten gains.

Jean-Michel Basquiat was an American artist who rose to prominence in the 1980s, and often lauded as one of the most influential artists of the 20th century. In 2013, his “Hannibal” painting—estimated to be worth about $8 million—was smuggled into the United States by a convicted Brazilian money launderer.

The former banker-turned money launderer, Edemar Cid Ferreira, assembled a large collection of artworks (including Hannibal) when he controlled Banco Santos in Brazil, a bank he founded himself. In 2004, his dirty financial empire collapsed, and he was sentenced to 21 years in prison. However, before his arrest, he managed to smuggle millions worth of expensive art out of Brazil. Hannibal managed to make it to American shores via the Netherlands, after false shipping invoices that stated the contents were worth $100 (the painting was subsequently recovered by the authorities and auctioned at Sotheby's for $13.1 million).

"Hannibal" by Jean-Michel Basquiat
"Hannibal" by Jean-Michel Basquiat sold at Sotheby's for $13.1m in 2016. Image: Stephen Chung/Alamy

But it’s not just former bankers and everyday criminals that use artwork to launder money. Terrorists also trade in artwork—including the Islamic State, which has sold on looted art and historical artifacts for years. “Once looted in Syria and Iraq, objects enter a gray market shrouded in secrecy,” Michael Danti, an archaeologist that advises the US State Department, reportedly said.

This problem has also been discussed by security officials in Europe. In France, one unnamed security official reportedly said “ISIS is increasing pressure on this line of trafficking to compensate for the loss of petroleum revenue.”

But how does laundering money in the art industry work in practice?

The art of money laundering

On a basic level, money laundering is a three-stage process: placement, layering, integration. Placement involves introducing cash into the financial system. Layering involves somehow disguising the true origins of the proceeds of crime to mislead law enforcement and regulators. Finally, integration is where the criminal(s) acquire wealth generated from what appears to be a legitimate source.

Let’s assume our money launderer has $5 million burning a hole in their pocket. They place an anonymous bid on a work of art—typically an anonymous bid is made via phone call—and if successful, suddenly that person has managed to place millions of dollars worth of dirty money into the economy. The first of the three money laundering steps is complete.

Next, the money launderer would need to integrate their laundered funds, perhaps by moving their purchase to a freeport. Freeports are a type of port where—typically—tax and customs rules apply differently. They can be found at airports or maritime ports, and imports can enter these locations with simplified documentation.

Per a 2020 study published by the Centre for Financial Crime and Security Studies at the Royal United Services Institute (RUSI), there are several concerns regarding freeports. Most alarmingly, freeports don’t tend to use reliable beneficial ownership records, which means that any hope of detecting the proceeds of crime is significantly impeded. Some freeports even allow goods to be purchased for cash, which increases their appeal to money launderers.

Using these blind spots, a criminal can simply sell their newly purchased artwork to the next buyer, and voila—they have regained wealth from a seemingly legitimate source, and in doing so, carried out the third and final stage of any money laundering process.

Yet there is hope. In 2020, Congress passed the Anti-Money Laundering Act, which, according to John Jefferies, chief financial analyst at CipherTrace, is starting to treat art trading like Money Services Businesses, suggesting that tighter regulation for the art industry is on the horizon. And NFTs could be next in line.

NFTs and dirty money

Jefferies told Decrypt that it’s “only a matter of time” until NFT trading platforms become categorized as VASPs and are regulated as such. This year alone, NFTs have generated billions in sales; renowned digital artist Beeple sold over $500,000 worth of digital art in just five minutes, before auctioning off a single NFT for $69 million dollars—the third-largest sale of an artwork by any living artist.

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But while Beeple is a long-time digital artist whose work precedes the booming NFT market, almost anyone can sell almost anything as an NFT. Consider this rough sketch of the Brooklyn Bridge that Monty Python’s John Cleese drew on his iPad; the NFT version last sold for more than $62,000.

Perhaps the only thing booming more than NFT sales volumes is just how much attention the digital art market is now generating. Recently, searches for NFTs reached levels equivalent to the 2017 ICO mania, while everyone from Snoop Dogg to Saturday Night Live has touted their own NFTs.

In theory, laundering money with NFTs is very simple; one post on Hacker News described NFTs as the “best money laundering method in the cryptocurrency world.” For starters, NFTs don’t need to be stored in a physical location. And most of the biggest NFT platforms operate with little or no KYC requirements—a cardinal sin for those interested in stopping money launderers in their tracks.

As with any other form of value transfer, there’s no denying that [NFTs] can be used for [money laundering],” Gary Nuttall, an emerging technology consultant who runs an NFT community Telegram group, told Decrypt.

Trade-based money laundering is a process that disguises the proceeds of crime by moving value through several trade transactions in an attempt to conceal their origins—often by misrepresenting a product’s price or quality.

“To use an obvious example, if a platform witnesses a user buy an NFT for $1M only to sell it two days later for $800K, that rapid loss is a red flag that money laundering is underway,” Jefferies told Decrypt.

Typically, this gives law enforcement agencies a window of opportunity. If a product that is clearly overpriced or underpriced is being traded frequently, this will arouse suspicions. However, this is a tall order when it comes to physical art, let alone NFTs that have absolutely zero sources of independent valuations.

If someone really believes that an NFT of Jack Dorsey’s first-ever tweet is worth over $2 million, who can say otherwise? Graffam gave the example of a shell company investing in an NFT. “If that artwork happens to lose significant value because the market is volatile and there potentially isn’t a precedent for a particular artist’s NFT value, they could then sell that artwork for significantly less to a second shell company owned by the same person, declare that deficit as a loss for their business and pay thousands less in taxes.”

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And would-be money launderers will surely take notice of NFT platforms like OpenSea, which doesn’t perform KYC checks and offers private sales. When someone creates a listing, that seller can specify a single address that’s eligible to purchase the NFT. “The way we see it, OpenSea's primary role is to help sellers find buyers for their digital assets,” the OpenSea website reads, adding, “If you already have a buyer lined up, we're happy to offer a safe and reliable way to make the exchange, free of charge.”

Money launderers could try to make use of private listings like this to mask the true origins of funds. “The ability to buy NFTs without some underlying KYC for participants may lead to illicit funds flowing into this market,” Hidalgo told Decrypt. We have contacted OpenSea and will update this article if we receive a response.

Hidalgo is not the only one that’s concerned. “We assume that many of those who buy and sell NFT tokens could be doing it for money laundering purposes; artworks don't have a standard pricing basis,” Jacob Sever, founder & CPO at ID verification firm Sumsub, told Decrypt. “They go for whatever figure the seller decides upon, or for however much a buyer is willing to pay.”

"We assume that many of those who buy and sell NFT tokens could be doing it for money laundering purposes."

One factor that works against money launderers looking to use NFTs is that the majority of NFTs are on the public Ethereum blockchain, which means that transactions are traceable. “With NFTs inherently operating on the blockchain, their origin and destination traceability is easier, providing a certain level of transparency for all transactions,” said Hidalgo.

Jesse Spiro, global head of policy at data analytics firm Chainalysis, reportedly said “In an ideal world, you’d be able to follow transactions, and then at the choke points where individuals were trying to convert whatever token they’re using into maybe fiat currency, they’d have to provide their [personal identifiable information].”

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This idea is backed up by Nuttall, who told Decrypt that while NFTs can be used to launder money, “an audit trail is laid as all transactions are written onto a distributed ledger that cannot be manipulated, erased, or hacked.”

What’s next for NFTs?

If the FATF does formally categorize NFT trading platforms as virtual asset service providers, this means that they will be considered as providing at least some of the same services as many crypto businesses that exist today.

These include exchanging between virtual assets and fiat currencies, exchanging between one of more forms of virtual assets, transferring virtual assets, safekeeping virtual assets or instruments that enable control over virtual assets, and finally, participating in financial services relating to the offer or sale of a virtual asset.

At a starting point, any regulation of NFT platforms would likely entail basic know your customer (KYC) measures, where buyers and sellers are identified by their real-world names and the source of their funds is declared before transactions are possible.

"NFT trading platforms can perform customer due diligence so they know their customers. They can also monitor the sources of money flowing in and destinations for funds flowing out of their platforms,” Jefferies added.

That proposal has angered some NFT enthusiasts, who claim regulation is out of touch with the nascent market. Much like the DeFi scene—where peer-to-peer transactions and pseudonymous developers are the norm—anonymous buyers and sellers of NFTs will make it extremely challenging to regulate the market.

Some NFT Sales Could Be Illegal: SEC Commissioner Hester Peirce

But even without worrying about money laundering, some NFTs currently being sold might already be breaking the law. According to SEC Commissioner Hester Peirce, some fractionalized NFTs might actually be unregistered securities.

Buyers and sellers might claim that the global effort to fight financial crime is out of touch with NFTs, but such arguments will cut no ice with regulators—who are already wrestling with the implications of the crypto space.


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