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The NFT Market Grew and Prospered, But Money Launderers Continued to Hold the Other Side in Check

NFTs (non-fungible tokens) may seem like a fad. Still, with over $10 billion traded in the third quarter of 2021 alone, it’s become clear that this emerging technology – a blockchain-based tool enabling anyone to monetize digital content – is growing into a significant industry. The massive growth of NFTs has led both individual creators and companies across diverse fields such as retail, music, entertainment, consumer products, fashion, and more to explore ways to engage actively. A partnership with a third-party platform offers more significant benefits than building one of one’s own NFT marketplaces since it reduces upfront costs, gives sellers access to a more extensive customer base, and can provide marketing, legal, and technical support services. While there are some factors to consider, we’ve found it particularly helpful to categorize NFT marketplaces on a spectrum from streamlined to augmented. Marketplaces that are “simplified” support a broader range of NFTs and provide more limited, generic services to sellers, while marketplaces that are “augmented” provide a more comprehensive experience.

There are also streamlined platforms that host both auctions and fixed-price sales for NFTs, such as OpenSea and Rarible, very similar to traditional platforms such as eBay, Etsy, or Mercari. Typically, such marketplaces focus primarily on facilitating efficient transactions, often offering payment infrastructure to accept credit cards and cryptocurrencies like Bitcoin, Ethereum, and sometimes other specialty tokens. Their breadth contributes to the breadth of their user bases, and they typically offer minimal additional services. The crypto industry has observed a trend: According to Google search data, non-fungible tokens, or NFTs, have almost attained the level of interest that initial coin offerings, or ICOs, had in 2017. It was no surprise that ICOs largely disappeared from the scene once the SEC started poking around and determining that, in some cases, they were being used to launder money. NFTs are being viewed by blockchain experts as ripe for abuse, despite their traceability – and perhaps even because of it.

Over the last three years, illicit decentralized finance (Defi) transactions have increased, according to a blog post on Chainalysis. The blog reports that the increase was mostly due to two areas such as hacking and money laundering using Defi protocols. According to the blog, the Defi protocols have been trending since 2021, reaching their peak levels in Q1 2022 due to the Ronin Bridge and Wormhole Network hacks. Since the beginning of 2020, Defi procedures have been responsible for an increasing portion of all stolen assets, and the majority of those monies were lost in 2021. According to the May 1, 2022 statistics, Defi protocols accounted for 97% of the $1.68 billion in stolen cryptocurrency. Reports indicate that wash traders on the NFT market lost money due to gas fees, while the successful ones artificially inflated the value of their NFTs and sold them to unsuspecting buyers. Chainalysis reported that two wash trading wallets generated over 650,000 wrapped ether (wETH) transactions for their Chainalysis Crypto Crime Report, 2022. These wallets generated a total of 106 million reward tokens worth over $185.5 million, starting from just 705.6 ether. A total of $114.6 million was paid in gas fees on the wash trades.

Another issue for NFTs is the practise of “wash trading,” which permits sellers to be on both sides of a transaction in order to present an inaccurate picture of an asset’s worth and liquidity. The problem of wash trading has historically arisen when cryptocurrency exchanges attempt to make their trading volumes appear larger than they are. Using NFT wash trading, one aims to make the original owner’s NFT appear more valuable than it is by “selling” it to a new wallet they control. As many NFT trading platforms allow users to trade simply by connecting their wallet to the platform, without identifying themselves, this should be relatively simple with NFTs.Blockchain analysis, however, allows us to track NFT wash trading by analyzing sales of NFTs to self-financed addresses, that is, addresses that were funded either by the selling address or by the address that initially funded the selling address. Some NFT sellers have conducted hundreds of wash trades with self-financed addresses, according to the analysis of their NFT sales.

There are murky legal aspects to NFT wash trading. NFT wash trading has not been subject to enforcement action yet, despite its prohibition in conventional securities and futures. This may change as regulators shift their focus to NFT markets and apply existing anti-fraud laws. Wash trading in NFTs can create an unfair marketplace for those purchasing artificially inflated tokens and undermine trust in the NFT ecosystem, inhibiting growth in the future. To protect NFT marketplaces from this activity, we urge them to discourage it as much as possible. Users who sell NFTs to self-fund addresses can be easily identified due to blockchain data and analysis, so marketplaces may consider banning or punishing them. Historically, money laundering has been a problem in the fine art world, and it’s easy to understand why. A recent article highlights how simple it is to transport works of art, relatively subjective prices, and possible tax advantages. It is, therefore possible for criminals to purchase art with illegally gained funds, sell it later, and voila – they have clean money without any reference to their original criminal activities. Many wonder if NFTs are vulnerable to similar abuses, given this background and the pseudonymity of cryptocurrencies. Despite the difficulty of quantifying money laundering in physical art, blockchain transparency will enable us to make more reliable estimates of money laundering in NFTs.

This activity represents a drop in the bucket compared to the $9 billion cryptocurrency-based money laundering we tracked in 2021. NFTs, especially those that involve transfers to sanctioned entities, pose a significant risk of money laundering. It is important that regulators, marketplaces, and law enforcement agencies closely monitor this activity. It recommends increasing information-sharing programs to boost transparency, updating guidance and training for law enforcement, customs enforcement, and asset recovery agencies, and strengthening anti-money laundering and countering the financing of terrorism regulations for specific market players who are not subject to the market Act, like financial institutions that use the art for collateral.


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