Last week, the U.S. Department of the Treasury released a report entitled “Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art” that discussed risks in the art sales ecosystem, ranging from high-value traditional art to NFTs and online sales platforms. Section 6110(c) of the Anti-Money Laundering Act of 2020 (AMLA), enacted as part of the National Defense Authorization Act for Fiscal Year 2021, had directed the U.S. Department of the Treasury to study the facilitation of money laundering (ML) and terror finance (TF) through the trade in works of art (the “Study”). The Study discusses which art market participants and sectors of the high-value art market in the United States present ML and TF risk, and that as a result may warrant regulation as financial institutions under the Bank Secrecy Act.
Part of the Study looks at the emerging digital art space, including NFTs and online platforms, and discusses characteristics that may lead to higher risk of money transmission and laundering vulnerabilities. Some NFT minters, wallets and sales platforms may already be regulated as money services businesses (MSBs) under FinCEN regulations. However, there are a number that are not, raising the question of where risk arises and where expanded regulation may be needed. The Study notes that because NFTs are digital assets that are unique (not interchangeable) and used as collectibles, they are generally not considered to be a cryptocurrency, and do not meet the Financial Action Task Force (FATF) definition of “virtual assets” for AML regulation purposes. However, if the NFTs are used for payment or investment purposes, they may fall under definitions of virtual currency that are subject to FinCEN regulation.
Similarly, the platforms that support sale and purchase of NFTs, as well as virtual mediums like metaverses, can be regulated MSBs, or in some cases currently are not regulated. The Study notes that “[t]o understand the application of AML/CFT obligations, it is important to consider the nature of the business dealing in NFTs and their function in practice as well as the facts and circumstances of the platform or other person doing business” (p. 26). The Treasury Department goes on in the Study to discuss how it views these art market participants and risks:
Other art market participants, including auction houses, galleries, third-party intermediaries operating as businesses, such as dealers and interior designers; peer-to-peer marketplaces; digital art marketplaces; online retailers; and any VASPs [virtual asset service provider] not covered under existing regulations that offer marketplaces for NFTs have potential ML vulnerabilities as described in this Study. However, different entities analyzed in this Study may present varying levels of vulnerability to ML, and ultimately risk to the U.S. financial system. For example, entities which have lower levels of annual sales turnover (such as small galleries) and entities that only occasionally transact high-value art (such as third-party online marketplaces, museums, other nonprofits) may present less risk, while entities which have larger annual sales turnover and regularly transact in high-value art in the ordinary course of business may present a higher risk. (p. 32)
Thus, it is not necessarily the case that the Treasury Department will seek to regulate NFTs and their minters or administrators (as with convertible virtual currencies), or that all online marketplaces and dealers for NFT are destined to be treated as financial institutions by FinCEN. The Study indicates open questions and nuanced views, and industry participants may be able to offer comments in future rulemakings to help shape FinCEN’s future approach.
Another point addressed in the Study is that some NFTs may be governed by smart contracts that generate revenue for the artist or original owner each time a transfer/sale involving that NFT is recorded on the blockchain. We have also seen fractionalization of NFTs that splits ownership into smaller fractions such that several people collectively own a single NFT. This concept makes it possible for smaller investors to pool resources to purchase these fractional interests of the NFT and caught the attention of the SEC last year as a potential investment product. These types of arrangements could increase the risk that a NFT transaction and companies supporting the transaction will fall under current or future FinCEN regulation. As such, the characteristics of the NFTs offered and how they are being used in practice should be carefully monitored and analyzed by the NFT platforms.
Thus, the Treasury Department has made clear in the Study that it is carefully monitoring digital art assets, including NFTs, and the forums and online marketplaces on which they are developed and exchanged. Even where NFTs and online platforms are not subject to current AML program, due diligence, recordkeeping and reporting obligations, they still are subject to U.S. criminal anti-money laundering laws under 18 U.S.C. §§ 1956 & 1957. Thus, the risks highlighted in the Study have immediate relevance. And businesses active in this digital part of the art world should consider whether their business models may be captured in a future FinCEN advance notice of proposed rulemakings (ANPR) or preliminary rules—leading to need for industry comment and, ultimately, some targeted regulation.