Treasury Department targets non-fungible tokens in report

0

The hot market for non-fungible tokens, or NFTs, continues to come under regulatory scrutiny. A Treasury Department report released on February 4, 2022 is the latest to focus on potential regulatory issues associated with this digital asset class.

The report, titled “Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art” is an extensive study of potential vulnerabilities to money laundering in the global art trade. In one section, it focuses on the emerging digital art market and the role that auction houses, art dealers and the growing number of digital commerce platforms are playing in the primary and secondary markets. NFTs.

The report notes that depending on the nature and characteristics of the NFTs being offered, platforms may qualify as virtual asset service providers (VASPs) under FinCEN regulations. Under these regulations, a VASP is any business that conducts one or more of the following activities or operations for or on behalf of another natural or legal person: (1) exchange between virtual assets and fiat currencies; (2) exchange between one or more forms of virtual assets; (3) transfer of virtual assets; (4) custody or administration of virtual assets or instruments enabling control of virtual assets; and (5) participation in and provision of financial services related to the offer or sale of a virtual asset by an issuer.

The Treasury observes that digital assets that are unique, rather than interchangeable, and that are used in practice as collectibles rather than instruments of payment or investment are generally not considered virtual assets under its regulations. The report, however, believes that NFTs or other digital assets used for payment or investment purposes in practice may fall under FinCEN regulations, and some NFT platforms and service providers may qualify as VASPs. , depending on the characteristics of the NFTs they offer. The report highlights that platforms or other persons doing business transferring virtual assets when buying or selling NFTs may have obligations under FinCEN rules for money services businesses if they do business in the States. -United.

The report also warns that NFTs can be used to perform “self-laundering,” where criminals can purchase an NFT with illicit funds and conduct transactions with themselves to create sales records on the blockchain. In this way, the Treasury hypothesizes that the NFT could then be sold to an unwitting individual who compensates the criminal with equity unrelated to a prior crime. The Treasury is concerned that the ability to transfer certain NFTs via the Internet regardless of geographic distance and across borders makes digital art susceptible to exploitation by those seeking to launder the illicit proceeds of crime , as the movement of value can be accomplished without incurring the potential financial, regulatory, or investigative costs of physical shipment.

Additionally, the report is concerned that the smart contract underlying an NFT may facilitate money laundering conditions. The report cites the example of an NFT smart contract which provides for the payment of a royalty to an artist for each sale of his work. The Treasury notes that such smart contracts could create an incentive to shape a market where labor is traded repeatedly over a short period of time. While this structure may ensure that artists are compensated for their work after the first sale, FinCEN posits that the activity may also be risky as the incentive to complete a transaction could be higher than the incentive to verify the identity of the purchaser of the work, or even may create a situation where it is not possible to exercise due diligence if the transactions are carried out in rapid succession. Additionally, FinCEN cautions that traditional industry participants, such as art auction houses or galleries, may not have the technical understanding of distributed ledger technology required to practice proper identification and effective verification of customers in this space.

Copyright © 2022, Hunter Andrews Kurth LLP. All rights reserved.National Law Review, Volume XII, Number 38

Share.

Comments are closed.