No Match Found
The hype surrounding non-fungible tokens (NFTs) skyrocketed in 2021 and NFTs led to million-dollar deals. An NFT is a unique and non-interchangeable digital asset registered on a blockchain that serves primarily as proof of the asset’s authenticity and ownership.
However, the boom in the NFT market also opens the door to criminal activities. Such crimes can include market manipulation or money laundering using NFTs by means of wash trading, which is the focus of this article.
In traditional finance, the term “wash trading” means the simultaneous buying and selling of the same security by the same owner with the intention of giving false or misleading signals about the supply, demand or price of securities. Wash trading constitutes a form of market manipulation under Article 143 of the Financial Market Infrastructure Act (FinMIA).
NFT wash trading aims to give market participants a misleading picture of an asset's value and liquidity. In doing so, an NFT will be sold at a higher price to a new wallet, which is also controlled by the original owner. Ultimately, an NFT appears more valuable than it actually is, and unsuspecting buyers believe that the NFTs they have bought have increased in value. The wash trader will only make a profit if he succeeds in selling the NFT to a third party at an artificially higher price. If the wash trader sells the NFT to himself, he makes neither a profit or a loss (except paying for market fees and royalties where applicable).
Interestingly, most NFT wash traders who sold an NFT to a self-financed address more than 25 times were unprofitable in 2021. A “self-financed address” means that the NFT is funded either by the selling address or by the address that initially funded the selling address. However, the successful NFT wash traders generated so much profit that the entire group of wash traders benefited greatly in 2021 (Chainalysis, The 2022 Crypto Crime Report, p. 34).
In order for NFTs to be successful in the future, growth to be achieved and unfair market behaviour to be curbed, NFT platforms must guarantee market participants a secure NFT ecosystem. One efficient possibility is to use blockchain data and analytics which identify users selling NFTs to self-financed addresses. Based on this, platforms may consider imposing penalties on the most harmful wash traders.
In addition to NFT wash trading constituting a form of market manipulation, money laundering by means of NFTs is also increasing. One way to launder money is by using NFT wash trading as described above. Since not all NFT trading platforms are regulated and the purchase and sale of NFTs with cryptocurrencies offer market participants a high level of anonymity, there is a higher risk of money laundering by cybercriminals. Since the beginning of 2020, the purchase of NFTs using illicit funds by cybercriminals has risen sharply. At the end of 2021, USD 1.4 million worth of cryptocurrency was sent from illicit addresses to NFT marketplaces. The vast majority of these funds used to purchase NFTs came from addresses associated with scams. There has also been a worrying growth in funds sent to NFT marketplaces from addresses with sanctions risk. In total, NFTs were purchased from these addresses using USD 284,000 worth of cryptocurrency (Chainalysis, The 2022 Crypto Crime Report, p. 35-36).
The purpose of money laundering in this space is to launder money from a criminal origin, a so-called predicate offence in the decentralised world of NFTs. To commit money laundering, scammers do the following:
Firstly, the money launderer buys a cheap NFT on a platform, for example on Opensea. Here, he uses clean money. Secondly, the NFT is offered for sale at a higher price on Opensea, and the money launderer buys this NFT from himself with the amount of black money to be laundered. As already mentioned, this generates an artificially higher value and price of the NFT. If the money launderer succeeds in selling the inflated token to a third party, the profit flows into the legal economy as clean money. This ultimately creates an apparent legal origin of criminal proceeds.
A conviction for money laundering under Swiss law is only possible if the criminal origin of the assets can be proven. Accordingly, the predicate offence affecting the assets must be a felony or a qualified tax offence.
In traditional finance, wash trading is a predicate offence to money laundering but only if a pecuniary advantage of more than CHF 1 million is generated. If the pecuniary benefit falls below this amount, it qualifies as an offence and not as a predicate offence for money laundering. When assessing whether NFT wash trading also constitutes a predicate offence to money laundering, the key question arises as to whether an NFT constitutes a security under the FinMIA.
Neither the legislator nor the Swiss Financial Market Supervisory Authority (FINMA) have issued regulations or guidance on NFTs specifically. However, the FINMA categorised tokens in 2018 based on their own approach according to the tokens’ underlying economic function/purpose. Thereby, tokens are qualified as either payment, utility, asset or hybrid tokens.
In order to be able to assess whether NFTs represent a security under financial market law, it must be checked whether NFTs can be classified as asset tokens.
Asset tokens in general represent a debt, equity or derivative claim against an issuer. These tokens are comparable to equities, bonds or derivatives. The FINMA treats asset tokens as securities if they fall under the definition of a DLT security (Art. 2 let. bbis FinMIA). Payment and utility tokens can also be securities, if for example they are sold in the pre-financing and pre-sale phases or if they have a speculative aim.
Because of this definition, in the majority of cases NFTs should not be classified as asset tokens. However there are exceptions, which means that each NFT needs to be assessed individually based on their specific characteristics and use case if they constitute an asset token. Fractionalised NFTs, where an NFT represents a share of a locked-up NFT, may thus be classified as an asset token.
Accordingly, it should therefore be assessed on a case-by-case basis whether NFT wash trading is occurring. If NFTs are not classified as asset tokens and therefore also not as DLT securities, it is less likely that NFT wash trading constitutes a predicate offence for money laundering. As mentioned above, particular caution is required in cases of fractionalised NFTs.
If it is not an asset token, however, this market interference is not exempt from the law. As such, if the NFT is not qualified as an asset token other offences such as cybercrimes could apply.
Anti-money laundering (AML) and Know Your Customer (KYC) obligations are key responsibilities of any financial intermediary. Failure to comply with these obligations leads to regulatory scrutiny as well as financial and reputational damage. We at PwC support our clients in the areas of AML and KYC for traditional financial services as well as for newer digital assets or crypto services. We help clients with proactive services such as FINMA licence applications, compliance frameworks, policies and procedures, contracts and forms or account opening review support. We also provide support on reactive matters such as file reviews or investigations, and so are always very close to the latest developments and activities in the area of financial crime compliance.
Dr. Günther Dobrauz
Partner and Leader Legal, PwC Switzerland
Tel: +41 58 792 14 97