Hype Fades, but Oversight Stays | Ingram Yuzek Gainen Carroll & Bertolotti, LLP

It was reported earlier this month that members of the European Parliament have proposed to designate NFT platforms (i.e., an entity or a person acting as an intermediary for importing, minting or trading the assets that represent proof of ownership of artworks or collectibles) as “obliged entities” under the EU’s anti-money laundering (“AML”) laws. What such amendment implies, by the nature of AML laws and practices, is that NFT marketplaces would have to reconsider whether their AML programs are robust enough to meet the statutory requirements or whether they are mandated to build an AML program from scratch to meet these requirements (although the lack of an existing AML program would be an unlikely case). Similarly, the Financial Action Task Force (“FATF”) also released a “Targeted Update on Implementation of the FATF Standards on Virtual Assets and Virtual Asset Service Provider ” in June this year, indicating that countries should apply FATF’s AML standards to NFTs if NFTs have the same functions as virtual assets, such as being used for payment or investment purposes. FATF further recognized that money laundering risks could arise from the use of NFTs in DeFi settings as crypto loans can now be secured by one or more NFTs through various DeFi protocols .

While the above developments are unlikely to result in a material impact on retail NFT investors and individual collectors, NFT marketplaces, on the other hand, might have to carefully consider the legal and compliance responsibilities ensuing from such developments and start reviewing the following two features supporting their AML programs:

1. Internal risk assessment:

Risk assessment has always been a fundamental component of an AML program. Given the unique nature of NFTs, NFT marketplaces will have to assess whether the methodology that they use to determine inherent risks (e.g., client risks and product/service risks) for their internal risk assessment will need to be adjusted in accordance with relevant factors, such how the NFTs are collected (by individuals/entities/DAOs) and how NFTs are used as collateral for loans in crypto. For instance, a client may be considered a low risk client in previous risk assessments given his/her verified wallet addresses, limited collection of NFTs and low volume of NFT trading and/or transferring activities. However, such client’s risk profile might warrant a reexamination if he/she has extensively pledged his/her NFTs to secure multiple loans disbursed by or from DeFi protocols that are known to be associated with money laundering or sanction evasion schemes. Also, it might also be appropriate to classify a client as a medium or high risk client if such client has been identified for his/her NFT wash trading, which, as FATF suggested in its targeted update, is one type of illicit financial activity.

2. Mitigating measures:

If the proposed amendment to the EU anti-money laundering laws is adopted, NFT marketplaces might also be required to reassess their money laundering mitigation measures so as to ensure that such measures are consistent with applicable statutory requirements or are adequate to mitigate the risks as identified by competent regulatory agencies. For instance, NFT marketplaces might have to review their transaction monitoring program to determine whether existing typologies and scenarios can capture the illicit activities associated with the use of NFTs in DeFi setting. Additionally, corresponding procedures and policies might also require revisions so as to reflect the adjustments made to the transaction monitoring program.

While the NFT landscape has been changing rapidly and will continue to grow given NFTs’ unlimited potential, laws and regulatory oversight will certainly catch up to safeguard the integrity of the markets. It is thus important to keep an eye on the developments in NFT/crypto-related laws and plan accordingly. Stay tuned to Ingram’s NFT Newsroom to learn more about the latest developments with NFTs.