NFT’s and money laundering: is your business at risk? 

May, 2022 - Shoosmiths LLP

Lauren Bowkett is a Principal Associate in the Financial Crime Team at Shoosmiths.  Her expertise is in white collar crime and Proceeds of Crime Act (POCA) related matters, with specific knowledge in the restraint and seizure of cryptoassets. 


In this article Lauren will consider the interplay between non-fungible token’s (NFT’s), a type of cryptoasset and the anti-money laundering regulations and comment on the issues faced by businesses with exposure to NFT’s in tackling money laundering in the digital world.


What is an NFT?

An NFT is a cryptoasset. Cryptoassets, are defined by the Financial Conduct Authority (FCA), for anti-money laundering (AML) purposes, as ‘cryptographically secured digital representation of value of contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically’.


A crypto asset is a digital asset that uses public ledgers over the internet to prove ownership. An example of a public ledger would be the blockchain, which is used to create verify and secure transactions. NFT’s are a unique non-fungible token, which cannot be replaced by something else, unlike Bitcoin, which is a type of cryptocurrency. Non-fungible means that it is unique. NFT’s exist on the blockchain and hold a unique digital signature, like a certificate of authenticity, that cannot be duplicated. They are ‘tokenised’. An example of an NFT would be digital artwork or music.


There are three categories of cryptoasset and a technical assessment of the type you hold is necessary to determine if it is a regulated or unregulated entity. Where your business is regulated it will be caught by the provisions of The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the Regulations). Breach of the Regulations is a criminal offence.


The regulation of cryptoassets (including NFT’s) from an AML perspective

The Money Laundering and Terrorist Financing (Amendment) Regulations 2019 give effect to the majority of the legislative changes required by the European Union’s Fifth Anti-Money Laundering Directive. The 2019 Regulations amend the 2017 Regulations to cover businesses that provide services of exchange and custody of cryptoassets. Businesses that deal in the transfer or storage of cryptoassets should be aware of the obligations placed upon them under the Regulations and associated legislation, and their obligation to apply to the FCA for registration and supervision.


The Regulations specify that regulated businesses must establish and maintain controls and procedures in order to mitigate the risk of money laundering and terrorist financing. Whether money laundering has occurred or not, you and your business can be sanctioned for failing to have adequate procedures in place.


It is imperative that you and your business understands the type of cryptoassets being dealt with and consider if they are either regulated or unregulated depending on their nature. If you are unsure make sure you seek advice on this as the ramifications could lead to a criminal offence being committed.


It’s also worth noting that whether your business is regulated or not, failing to correctly identify the type of cryptoasset, and dealing in them without adequate controls, exposes your business generally to money laundering risk.


NFT’s and the lacuna in the AML legislation

Although many NFT’s fall into the category of being unregulated, that is not always the case and some may be regulated and covered by the Regulations. This is because NFT’s are cryptographic, which means that they use computerized encoding and decoding of information. However, they are non-fungible and unique. This means that an NFT may fall into one of the regulated identification categories and will therefore be regulated.


Whether the NFT falls into the Regulations or not is all dependant on their specific features, and you should seek advice to identify the type of NFT you are dealing with. In the absence of precise identification, it would be wise to follow the spirit of the Regulations to avoid the risk of committing a criminal offence.


What are the risks associated?

To buy an NFT purchasers need a digital crypto wallet to store their crypto currency. A crypto wallet could be an app that allows users of cryptocurrency to store and retrieve their digital assets, in the digital world. Similar to the concept of Apple Pay on your mobile phone. NFT purchasers can then connect their wallet to the marketplace they plan to buy their NFT from. NFT’s are usually sold through an auction site. However, there are some sites which allow you to buy NFT’s immediately.


There are several money laundering risks associated with the purchase of NFT’s which could leave you and your business vulnerable:


  • They are volatile. NFT’s can have substantial value, and this means they are increasingly being used as a method to launder money.
  • They can be transferred from one digital wallet to another in moments. This makes it difficult for law enforcement to capture criminal assets and money as it can move around the digital world instantly.
  • Large sums of money can be transferred anonymously from one digital wallet to another. It is possible for criminals to hide their identities during the money laundering “process” through the use of a Bitcoin wallet which does not require verification.
  • The majority of crypto exchange platforms are unregulated; therefore, they will not adhere to the Know-Your-Customer (KYC) and other identification guidelines which form part of the Regulations. However, it should be noted that crypto exchanges which have a presence in the UK have registration requires with the FCA and must comply with the Regulations.

Conclusion

It’s easy to become bamboozled by the terminology used in the scope of NFT’s but being unaware of your business’s obligations in the digital sphere will not afford you a defence if you breach the Regulations. You and your business will face the same sanctions if you fail to take all reasonable steps and exercise all appropriate due diligence when dealing with NFT’s. Your business must fulfil its obligations under the Regulations if your business is within the regulated sector. This will include:


  • making sure your business carries out regular risk assessments
  • that you have policies and procedures in place to mitigate the risks of money laundering
  • that you carry out effective due diligence on all of your customers
  • and that you keep records of the customer due diligence undertaken together with any transactional history.

If your business in not caught by the regulations the way your business deals with cryptoassets, and in particular NFT’s, should be carefully considered. Dealing with a potentially unregulated entity and not carrying out the appropriate checks could leave your business susceptible to becoming a mechanism for crime, which could then lead you and your business to being involved in the commission of a criminal offence.


Shoosmiths have a dedicated Financial Crime team that can carry out a detailed review of your business to advise if you are caught by the Regulations we have discussed in this article. The team can provide advice on AML and other crime compliance policies and procedures and have specialist expertise in respect of cryptoassets. If your business deals in the transfer or storage of cryptoassets our Financial Crime team can guide you through the process to make sure you have procedures in place to protect you and your business from money laundering to make sure that you do not commit a criminal offence.


Further information on how we can assist in creating a robust crime compliance programme, more information is available to view here.


 



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