Washing trading and money laundering on NFTS: What's the difference?
Laundry and money laundering in NFTs is a fraudulent activity that manipulates market prices and promotes illegal financial transactions in the world of digital art.
Fundable Tokens (NFTs) continue to shape the digital landscape and are attracting attention from people with malicious intent as they provide creators with new ways to monetize their works.
Two of the most concerning fraudulent activities in the NFT space are wash trading and money laundering. These practices are illegal and undermine the integrity of the NFT market by artificially inflated prices and introducing illegal activities that can have serious financial and legal consequences.
However, there are a variety of purposes and ways of operation. Let's break down each exercise.
Wash the trade
- meaning: Wash trading is a method used to deceive the market by artificially inflated the demand and value of NFTs through fake trading. The purpose is to manipulate the recognised value of an asset without the actual exchange of ownership.
- How it works: Those who run wash trades exchange and sell the same NFTs between the different wallets they control, creating a false sense of market interest.
- Objective: The goal is to mislead buyers and believe that NFTs are truly more valuable. Once perceived value swells, NFTs are sold to buyers who are unsuspecting with price increases.
- Market impact: Cleaning transactions can create movement in the artificial market, misleading potential buyers, and inflate prices without actual demand. It does not necessarily involve the use of illegal funds, but it distorts the market.
Money laundering
- Meaning: Money laundering in the NFT market refers to the process of disguising illegal funds as legal revenue by purchasing NFTs with dirty money and then reselling them to “clean” the funds.
- How it works: Criminals use illegally acquired money to obtain NFTs and after reselling the NFTs, the funds look legal. They can transfer NFTs through various wallets and platforms, and even hide trails.
- Purpose: The main goal is to hide the source of illegal funds and to appear to be from legitimate sources by involving NFTs in the transaction.
- Market Impact: Money laundering does not manipulate prices directly, but exposes NFT platforms to significant legal and regulatory risks. It is a financial crime that can damage the reputation of the entire market.
Wash trading is designed to manipulate prices, while money laundering utilizes NFTs to wash illegal funds. Both pose great threats to market transparency and the broader financial system.
Here's a brief summary of how wash trading NFTs differ from money laundering:
NFT cleaning process
NFTS washing transactions include repeat transactions between controlled wallets, misleading buyers, and inflated prices through market distortions.
The NFT washing trade works as follows:
- Initial purchase or creation of NFT: Individuals or groups have acquired or built NFTs on the market or blockchain platform.
- Selling NFTs to yourself: The individual then sells to another wallet that controls the NFT or to a collaborator's wallet. Usually in the same market. This repetition before and after transactions increase transaction volume and creates an illusion of NFT demand.
- Increase in artificial prices: These repetitive transactions will gradually increase the price of NFTs. New buyers who notice a sudden surge in value may believe that their assets are in high demand.
- Final sale at an inflated price: After the price swells through multiple cycles of trading, wash traders sell NFTs to unsuspecting buyers.
In October 2021, Cryptopunks NFT “Cryptopunk 9998” was involved in laundry sales at Ethereum. It was sold for 124,457 ether (ETH), but the funds returned to the buyer and repayed the loan used for the purchase. This case combines flash loans with NFT money laundering.
On April 5, 2022, Bloomberg reported that data from NFT trackers' Cryptoslam showed that bathroom transactions were $18 billion, or 95% of the total trade volume, in the NFT market, known as the NFT marketplace.
As seen from the example above, the dangers of washing transactions lie in their ability to distort the market, creating false value perceptions and leading to potential economic losses for those who fall into deception.
How criminals use NFT for money laundering
Money laundering via NFTS is a sophisticated process that uses the decentralized nature of blockchain technology to hide illegal funds.
NFTs can be used for money laundering due to the nature of pseudonyms and the ease of transferring assets across borders. Scammers and operators such as Chatex (Russian-based cryptocurrency exchanges and Telegram Bots) have been able to use NFTs to wash their funds and hide the true origins of money through crypto assets by promoting illegal transactions. It was approved by the US Treasury in November 2021.
Here's how criminals typically use NFTs to wash their money:
- Buy NFTs with illegal funds: Criminals use money from illegal activities such as fraud and drug trafficking to buy NFTs. The anonymity provided by blockchain transactions makes it difficult to track fund sources.
- Selling NFTs at inflated prices: After obtaining NFTs, the offenders sell them at an inflated price to an accomplice or related party. These sales are tied to the expected value of NFTS, making the revenue appear legal.
- Layer Transactions: To further obscure the source of funds, criminals may move NFTs between wallets or sell them on different platforms. This obfuscation makes it difficult for authorities to redirect money back into criminal activity.
- “Clean” money integration: Once funds from these transactions pass several layers of laundry, the “cleaned” money can be withdrawn, converted into Fiat currency, or reinvested in other legitimate assets.
Regulations regarding NFT Wash Trading
It is still under development in relation to NFT regulatory environments, particularly in relation to the laundry trade and money laundering.
Although there are no universal regulations specifically targeting NFT wash trading at the global level, some comprehensive regulations could apply to the cryptocurrency market and affect the NFT platform.
- US Securities and Exchange Commission (SEC): In the US, the SEC has begun scrutiny of the digital asset market, including NFTs. While NFTs themselves may not qualify as securities, washroom trading practices may fall within the scope of the SEC if they are considered to mislead investors or manipulate the market.
- Money Laundering Anti-Money Laundering (AML) Method: Various countries, including members of the European Union, are considering stricter money laundering (AML) laws regarding electronic money tokens. However, NFTs are partially regulated in the cryptographic (MICA)-regulated market and can be included depending on whether they meet certain criteria of originality and non-comprehensiveness. The ESMA advises that it is intended for use in determining regulatory applicability by individual evaluation of NFTs based on technical characteristics.
- Financial Conduct Task Force (FATF): The global regulatory body, FATF, has issued guidelines for digital assets, including NFTs. These guidelines encourage NFT platforms to implement knowledge of customer (KYC) procedures, monitor transactions for suspicious activities, and report abnormal transactions to authorities. Specifically, FATF guidelines provide insight into when NFTs are considered virtual assets (VAS). NFTs are classified as VAS when used for payments, investments, or finalised.
Examples of enforcement measures against NFTs
In 2023, the SEC denounced Impact Theory, a media company focused on the motivation and personal development to sell eligible NFTs as investment contracts based on the 1946 Howie Test.
The SEC claimed that this would create reasonable expectations of profits based on the company's efforts and create NFTS securities. Another important factor in the SEC decision was the presence of resale loyalty, with creators earning a percentage from future NFT sales.
This is the important details.
- NFT Sales and Financing: Impact Theory sold 13,921 NFTs (founder's keys) between October and December 2021, raising approximately $30 million in ETH from US investors.
- Marketing and Promise Perks: Buyers were promised exclusive perks, including digital collectibles, discounted NFTs, content, meetings and access to courses.
- The SEC focuses on investment claims: The company touted NFTs as early stage investments in major media brands, highlighting potential profits and comparing them to startup equity.
- SEC Enforcement and Refunds: In response to regulatory scrutiny, Impact Theory bought back 2,936 NFTs and returned $7.7 million in ETH to investors.
Regulations surrounding NFT wash trading and money laundering are still in their early stages, but increasing volumes could promote a more comprehensive legal framework in the near future. As the market matures, the demand for clearer and more enforceable laws increases.
How to protect yourself from NFT fraud and illegal transactions
Buyers and sellers can reduce the risk of NFT fraud by checking creators, checking transaction history, avoiding sudden price spikes, using reputable markets, and reporting suspicious activity.
To minimize exposure to these activities, the steps that buyers and sellers can take are:
- Check out NFT Creators: Always ensure NFT credibility by checking the creator's profile. Many platforms offer validated profiles that help establish legitimacy.
- Check transaction history: Check your NFT transaction history. Repeated transactions between the same wallets can be a sign of a washing transaction.
- Note the price spikes: If NFTs suddenly raise prices without major external factors or marketing activities, it could be a sign of market manipulation.
- Stick to a reputable market: Implement security measures and use trusted platforms such as Opensea, Superrare, and Rarible, which are unlikely to engage in fraud.
- Report suspicious activity: If you encounter any suspicious behavior or transactions, please report it to your jurisdictional platform or legal authority to maintain a safer market.
Protecting yourself from NFT fraud starts with awareness and attention. Don't just trust hype – do your research and if the deal feels too good, it's probably true. Report suspicious activities to help keep your space safer for everyone. In a rapidly moving world of NFTs and cryptocurrencies, skepticism is your best defense.
