With prices for some NFT’s reaching into the millions while the artwork itself is rather questionable, the idea that NFT’s can be abused for money laundering is not far-fetched.
So are NFT's a good way for criminals to clean their money?
What is money laundering?
Money laundering is the process of feeding illegally obtained money into the legal economic cycle. The goal of money laundering is to conceal the source of the money that usually comes from criminal activities like corruption, robbery, drug dealing etc. After laundering the money it gets out of reach for law enforcement agencies to track and confiscate, as it was now legally earned on paper. Money laundering is undertaken in three steps:
placement
layering
integration
Placement
In the first phase the criminal money is introduced into the legal economic system. The most common methods that are used to do this include:
gambling winnings
cash-intensive businesses
trading luxury goods (such as art)
Layering
This step is used to disguise the source of the money. This can for example be done by making multiple transactions back and forth. The more complicated ways the money takes the less likely it is that law enforcement can track the source down. With every transaction the money becomes more “clean”
Integration
Now that the money is circulating in the legal economy and the source of it has been properly disguised it can be used for any financial activities.
Using art to launder money
So what does all of this mean in the context of art business? The art market has often been accused of being an ideal vehicle for laundering money. The unique aspects of it attract criminals:
subjective value
hardly regulated market
often anonymous
Art pieces can be auctioned off for artificially inflated prices, taking advantage of the subjective and intransparent value of art. Auction houses often keep secrecy of the buyers and sellers name, making it harder to track them down afterwards. In 2018 the EU proposed a law requiring all transactions over 10.000 euros to be documented by the auction house making it possible to track the identity of the customer.
What makes the NFT market different
However blockchain technology works a bit differently. With recent regulations seen in the art market - a blockchain really is harder to regulate due to its decentralisation. The main aspects that make NFT’s an ideal product for money laundering right now are:
no identification required for most trading platforms
decentralized network
artificially inflated or subjective prices
no physical art that has to be stored
As you can see all of these elements make for a dangerous cocktail. Some even say NFT’s are the best method for laundering money using crypto. The prices are just jumping too fast for art pieces that arguably don't really have any substantial value. The NFT is what makes the art worth something in the end, by making it unique and rare. But it also means it is even easier than before to inflate prices without any substance. Is a tweet by Jack Dorsey really worth $ 2,9 million? It almost screams for exploitation by criminals looking for a way to clean their money. Looking at what happened to bitcoin, which was used a lot for illegal activities in the early days and then became regulated because of that - the future for NFT’s don't look too bright.
The full laundering process
But how would this work in a practical example? If I just buy an inflated piece of art that should still be noticed by law enforcement - after all the money has to somehow come onto the blockchain first, which should be traceable somehow right? Right but also wrong. While it is true that Ethereum is a public blockchain, meaning that transactions are traceable, the crucial parts are the endpoints, where cryptocurrency is traded into fiat. As most NFT platforms don’t have any form of identification required, tracking down individual persons is still complicated.
Knowing this the process of laundering your money using NFT’s can be alarmingly simple:
The criminal buys an NFT from an unknown buyer. The first step of the money laundering process is done, his money is in the economic cycle. Now the criminal resells the NFT for a significantly lower price to a 3rd account. The criminal now realizes his loss to offset tax liabilities. This can be repeated over and over.
Conclusion
So are NFT’s a good way to launder money? The short answer would be yes. But it's often more complicated than we think. While the fluctuating prices that reach into the millions are a good way to conceal suspicious transactions, the entry points where crypto is changed into fiat are a problem for criminals. Also the transaction itself is rather easy to trace for law enforcement as ethereum is a public blockchain.
Looking at possible upcoming regulations I think the most likely policies will follow the real world counterpart. With the know-your-customer principle that was already introduced into the physical art market I am certain upcoming policies will force NFT marketplaces to identify its customers in the future. If this will end money laundering using NFT’s - I highly doubt it. But it's probably a step in the right direction.
Disclaimer:
This article aims to educate the reader about how money laundering works for the special case of NFT’s. By no means I advise you to actually apply any of the presented strategies. Money laundering is a criminal offense according to federal law.