Non-fungible token and money laundering: an uneasy relationship

By Akarsh Singh, a IIIrd year B..B. A. LLB. student at Christ University, Bangalore.

Introduction

A non-fungible token is a digital asset which is stored and available on the blockchain, which is unique and cannot be replicated hence the term “fungible” being denoted in its terminology , the token can be an electronic video or a photo which would then be owned by a particular individual by his or her blockchain address clearly demonstrating the ownership of the particular , thus a certificate of ownership if provided , by the individual who owns the digital asset

The NFT is traded , created and sold in platforms such as opensea and rariblein exchange for decentralized currencies such as ethereum or bitcoin , in exchange the person who buys the digital asset gets an certificate of ownership which is then represented by his or her blockchain address.

The NFT supermarket has been estimated to have surpassed 40 billion dollars in 2021, with high profile celebrities such as Shawn Mendes and Paris Hilton creating their own token for buyers to Buy.

This has eventually attracted criticism and many terms the NFT market as a “bubble” and a tool used by criminals to launder money with ease, there have also been concerns about the copyright issue regarding these digital assets and the speculative asset mania, it has created which has drawn comparison to the dotcom bubble in the early 1990ss which lead to bankruptcy of several tech companies whose stocks were heavily overvalued before it all came crashing down in the early 2000s.

OFAC Sanction list:

The office of foreign asset control (OFAC) is an enforcement department under the control of American treasury department which regulates and governs economic and trade sanctions for the benefit of safety and foreign policy of the United States.

It targets a group of entities, groups, individuals and companies which are primarily terrorist or receive funding from terror groups and are narcotic suppliers indulging in the illicit trade of drugs, the sanction list in sometimes even targets governmental bodies which may seek to destroy and compromise American security such as Iran.

Strict and harsh penalties are prescribed to American individuals and financial services which seek to break the sanctions list and indulge in trade with by them , by either being a middlemen or a the direct individual or company allowing them to access the American financial system , this has been proved by fines being imposed by OFAC on BNP Paribas which is a global bank for breaking the sanction list and allowing Sudan , Iran and Cuba access to American financial markets , the matter was settled for a record settlement of 9 billion dollars which was paid by BNP Paribas to the American government.

Observation by regulatory bodies on money laundering through NFTs

The American treasury department published a study recently on feb 4^th 2022 , where it said there had been irregularities In the online digital art market where and there is some evidence of widespread money laundering in the digital art market , it further elaborated that the financial services who are not subject to money laundering laws are used by criminals in an effort to exchange money for financial criminal activities , although the treasury department clarified that there was a less risk of terrorism related activities being financed , other sort of illegal activities such as drug smuggling is being used by criminals.

It further states that asset based lending which is the main theme in the NFT market is used as a tool by criminals to disguise the original source of the funds and provide liquid funds to be financed by them.

There have several issues to regulate and detect money laundering through the creation and sale of digital art tokens as these exchanges are not a subject to money laundering laws and can only be sanctioned through OFAC directly through banning these blockchain address which was done recently.

In other jurisdiction such as china, the people’s bank of china has already warned regulators that the metaverse and the digital art industry or NFT could easily be used as a tool to launder money from one jurisdiction to another without any oversight or clearance by regulatory bodies in the due process.

Indian regime: issues and possible solutions:

Although there is 30% capital gain on digital asset being proposed by the gains which arise from sale of digital assets, there need to be clarity as to whether what the government’s plan is to regulate the free flow and exchange of liquidity which would finance criminal activities.

1. A strict adherence to know-your customer (KYC) and aadhar details being registered by the participants indulging in the digital art industry would be a step in the right direction as it would provide the regulatory bodies information on who buys and sells through digital asset and for what purpose , suspicious blockchain address need to monitored in that regard and flagged by a regulatory body which would have expertise in such a technology.
2. It is also highly important that the Government makes a consolidated sanction list which would be autonomous in nature , as in the present, India clearly lacks them, a consolidated sanction list would help provide exchanges which facilitate the digital art trade to properly enact and execute the sanction list put forward by the Indian government.
3. Another major issue in regards to NFT is in regards to “wash trading” which involves artificially inflating a price of an asset , which basically involves the buyer and seller being the same entity or individual controlling the transactions , in an effort to regulate this and protect the stakeholders involved in the trade , exchanges of NFT , it is highly imperative that the government of India sets up a regulatory body especially which would regulate the sale and purchase of digital assets and currency , it would be akin to SEBI but would regulate transaction happening in the metaverse ,registration of exchanges , parties participating in digital trade should be a set of rules which should be formed in the due process.
4. A close nexus and alliance between exchanges and governmental regulatory agencies,  is required which would help the Indian government with issues in regards to identifying suspicious activities and trades happening in such exchanges , the recent event of Opensea being hacked must serve as a reminder to the stakeholders of NFT and the government , why regulation and intervention by state agencies is required to protect all the stakeholders in digital trade. This type of an alliance should be enforced through the signing of MOU or contracts which would give governmental regulatory agencies oversight over all the transaction originating in India, including those which involve only buying and selling.
5. Furthermore, certain suspicious blockchain addresses which are deemed to exhibit behavior closely linked to activities such as money laundering should be blocked by the government provided swift reporting standards and procedures are maintained by the digital art exchanges and transparency of the highest order is maintained.

Although these reforms would take a lot of time and money , it is highly important for the Indian government to take note , as illicit trade through digital art exchanges have a shown a upward trend in recent times.