Digital& NFT

Will The U.S. Treasury Declare War on NFTs?

The U.S. Department of the Treasury is perhaps the most important government entity that the U.S. citizenry deals with on a daily basis. Regardless of which party is in control and regardless of what the politicians come up with on any given day, the Treasury is who actually prints up the money you use every day. And if the money isn’t printed, it is legered electronically for your accounts.

Outside of the Treasury printing money, they also focus on money laundering and terrorism financing. The Treasury released a 33-page study of how high-value art can play a role in terrorism financing and money laundering and how these pose risks to the U.S. financial system. The study was mandated by Congress in the Anti-Money Laundering Act of 2020. To conduct the study the Treasury interviewed dozens of auction houses, galleries, financial institutions, art advisors, art experts across the U.S. government, international partners regulating the art sector, and academic and non-governmental organizations.

In reality, both fine art and non-fungible tokens are a part of this effort. And both fit right within the realm of collectibles. While the U.S. Treasury study is not a declaration of war on fine art and NFTs, the reality is that a deep regulatory effort is possible as the government continually seeks to stop money laundering and terrorism financing efforts.

The Treasury’s view is that certain aspects make high-value art attractive for money laundering by criminals. These are how high-value art is bought and sold, and also lists “certain market participants” in the transactions, transportability, a deep culture of privacy, and even the use of shell companies and art advisors as intermediaries.

Where the report gets interesting is that the Treasury also directly addresses a risk of high-value art as an investment class. Make that an alternative asset class, but who is keeping score.

The good news for the high-value art market is that, while there is some evidence of money laundering risk, there is limited evidence of terrorist financing risk.

The Treasury did specify that businesses offering financial services in this market (collateralized loans) are most vulnerable to money laundering. According to the study, asset-based lending can be used to disguise the original source of funds and can be used to give liquidity to criminals.

The Treasury further found that entities lower sales turnover have lower risk than those entities with large sales and with frequent transactions.

Where the report gets more interesting and less obvious is that the Treasury’s study identifies the emerging digital art market — non-fungible tokens (NFTs). The Treasury noted that NFTs and digital art, depending on the structure and market incentives, may present new risks.

The evaluation of NFTs specifically is not brought up until page 25 of the study, but NFTs are referred to as bearer instruments. NFT platforms such as Dapper Labs, SuperRare, and OpenSea were all noted as potentially being considered virtual asset service providers and that they may come under FinCEN’s regulations. Still, the Treasury’s study did break down the differing views of the unique collectibles versus items used for payment or for investment:

Digital assets that are unique, rather than interchangeable, and that are used in practice as collectibles rather than as payment or investment instruments, depending on their characteristics, are generally not considered to be virtual assets under the FATF definition. NFTs or other digital assets, however, that are used for payment or investment purposes in practice may fall under the virtual asset definition, and service providers of these NFTs could meet the FATF definition of a VASP. In this context, some NFT platforms may qualify as VASPs, depending on the characteristics of the NFTs that they offer.

And for actual susceptibility the study points out:

The ability to transfer some NFTs via the internet without concern for geographic distance and across borders nearly instantaneously makes digital art susceptible to exploitation by those seeking to launder illicit proceeds of crime, because the movement of value can be accomplished without incurring potential financial, regulatory, or investigative costs of physical shipment.

Several non-regulatory and regulatory options are presented here to assist in preventing money laundering efforts. Information-sharing programs, using FinCEN recordkeeping authorities, using the tools to identify suspicious activity reporting and know-your-customer procedures are among some of the broader options and recommendations. All of these are of course just suggestions at this point.

One issue noted at the end of the study does identify how art transactions could become similar to money management rules. The Treasury’s study said that institutions selling near the range of $500,000 to $1,000,000 in annual sales could be subject to requirements such as maintaining a customer identification program.

Scott Rembrandt, Deputy Assistant Secretary for Strategic Policy in the Office of Terrorist Financing and Financial Crimes, said of the study:

As we tackle systemic challenges like corporate transparency and other loopholes that allow criminals to abuse the US financial system, we will look at what else might be needed to address money laundering risks specific to other industries, including the art industry.

Categories: Digital& NFT, Fine Art

Tagged as: ,